RBI keeps rates unchanged : The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) unanimously decided to keep the policy repo rate unchanged at 5.5%, maintaining a neutral stance. The real GDP growth forecast for FY2026 has been revised upward to 6.8% from 6.5%, while 1QFY27 GDP growth is projected at 6.4%. Meanwhile, the average inflation estimate for FY2026 has been lowered by 50 basis points to 2.6%. Additionally, the policy introduced regulatory measures aimed at strengthening the financial ecosystem and promoting the internationalization of the Rupee.

Banking liquidity remains in surplus : Liquidity has remained in surplus since the end of March 2025 and is expected to remain comfortable till January 2026 aided by drawdown of government cash balance and infusion of ~INR 2 trillion by the remaining 75 bps of CRR cuts. There was a small move into deficit in September due to GST related outflows.

As per RBI's revised liquidity management framework, it will discontinue the 14- day variable rate repo (VRR) and variable rate reverse repo (VRRR) operation and instead will manage liquidity primarily through 7-day VRR/VRRR, with other tenors upto 14-days to be used as per its discretion.

Inflation falls inches up : Headline inflation inched up to 2.1% in August vs 1.55% in July due to a broad based marginal uptick across categories barring food inflation. Meanwhile, food prices continued to moderate further. Core inflation remained steady at 4.1%.

US treasury yields fall : The yields on US Treasuries fell 8 bps with the 10 year yield closing at 4.15%. Earlier during the month, the Federal Reserve (Fed) lowered its interest rate by 25 bps for the first time since December and indicated more cuts would follow to halt any slide in a labor market already experiencing higher joblessness.

Market view

The Fed's 25 basis point rate cut in its September 2025 policy meeting provided a supportive backdrop for Indian bond markets. This move contributed to a flatter yield curve, largely driven by expectations of reduced supply in longer-dated government securities (G-Secs). The government revised its borrowing calendar, trimming the supply of longer-tenor government bonds by 5% and reallocating issuance toward the 3-year, 5-year, and 10-year segments. Consequently, bond yields remained range-bound throughout the month.

The RBI's monetary policy was the key catalyst for bond market sentiment during the period. Uncertainty around tariffs and expectations of a softer inflation trajectory-partly due to anticipated GST rate rationalization-have created room for an additional rate cut in the current easing cycle. The RBI held rates steady in October, a view that we had shared earlier. We assign a high probability to a 25 bps rate cut in December. Should the tariff impasse persist, an additional 25 bps cut could materialize in February.

With 100 bps of repo rate cuts already delivered, we believe the majority of the RBI's rate easing is now behind us. We believe that the best of the duration play is behind us. Given that inflation expectations remain well within the central bank's target range, we foresee a "lower for longer" interest rate environment.

Looking ahead, with limited scope for further aggressive rate cuts, we expect the RBI to maintain its accommodative liquidity stance (+1% NDTL). This should continue to support the shorter end of the yield curve. From a medium-term perspective, we favor accrual strategies over duration plays. We expect 10yr GSec to trade in a range of 6.30-6.65% for the remaining part of the financial year.

Fiscal concerns on the back of GST cuts coupled with worries on end of rate-cut cycle, led to an increase in the yields over the past few weeks. However in the near term, markets will be guided by lower inflation, pressures on growth, likely OMOs during Jan-Mar 2026 and possibility of inclusion in Bloomberg indices, which may provide a tactical opportunity for long bond investing.

As expected by us, the Fed lowered its interest rates against a backdrop of increasing unemployment. We expect another rate cut in the pipeline.

Risks to our view: The risks to our view at this point are as below
1) Currency
2) Growth shocks globally and in India

Strategy - We have gradually reduced duration in our portfolios since February 2025 transitioning from long duration strategies to accrual-based strategies.
We have been focused on the short term 2-5 year corporate bonds in the portfolio as we expect surplus banking liquidity, lower supply of corporate bonds/ CDs due to slowdown and delay in implementation of LCR guidelines and attractive spreads and valuations. Incrementally short bonds can outperform long bonds from risk-reward perspective due to a shallow rate cut cycle, lower OMO purchases in the second half of the year and a shift in focus to Govt Debt to GDP targets.

What should investors do?
• In line with our core macro view, we continue to advise short- to medium-term funds with tactical allocation of gilt funds to our clients.

Source: Bloomberg, Axis MF Research.