India’s inflation hits 8-year low; bond market awaits RBI’s next move: PGIM’s Puneet Pal

Bond yields softened across most maturities in October, barring the very long end of the curve, as the Reserve Bank of India (RBI) struck a dovish tone in its October 1 Monetary Policy Committee (MPC) meeting while keeping policy rates unchanged.

According to Puneet Pal, Head – Fixed Income, PGIM India Mutual Fund, the RBI’s decision to lower its FY26 inflation forecast to 2.6% from 3.7% in June and revise GDP growth upward to 6.8% from 6.5% gave markets comfort that the central bank remains focused on supporting growth amid easing inflation pressures.

The MPC retained its “Neutral” stance, though two members — Dr. Nagesh Kumar and Prof. Ram Singh — suggested shifting toward an “Accommodative” stance. “The RBI’s tone was distinctly dovish, which fuelled optimism in the bond market regarding potential rate cuts ahead,” noted Pal.

RBI Intervention to Support INR Drains Liquidity

In an unusual move, RBI Governor Shaktikanta Das highlighted the recent weakness and volatility in the rupee, assuring that the central bank “is keeping a close watch on INR movements and will take appropriate steps as warranted.”

Pal pointed out that the RBI’s intervention in both spot and forward markets to support the rupee has drained liquidity, leading to pressure on money market yields despite the 50-bps CRR cut announced earlier in the month. However, he added that optimism over potential rate cuts and reassurance around fiscal prudence helped cap yields.

Inflation at Multi-Year Low; Core CPI Edges Higher

India’s Consumer Price Index (CPI) inflation fell to an eight-year low of 1.54% in September, averaging around 1.7% for the quarter — below the RBI’s 1.8% projection. “It was the lowest CPI print since June 2017, driven by benign food inflation,” said Pal.However, core inflation edged higher to 4.6% in September from 4.2% in August, while core CPI (excluding food, fuel, gold, gasoline) remained steady at 3.3%. Pal attributed the rise partly to higher gold prices and an unexpected uptick in housing inflation, which rose 0.8% month-on-month, a deviation from the typical flat trend in September over the past five years.

He added that GST cuts could help ease core inflation in the coming months and suggested that the RBI might further lower its inflation target in the next MPC meeting.

Yield Curve Steepens; Long-End Demand Remains Weak

“The yield curve steepened again in October despite lower borrowing at the long end in H2,” observed Pal. Yields fell sharply in the first half of the month but reversed partially after a weak long-term bond auction reignited concerns around demand-supply imbalances.

By month-end, the benchmark 10-year government bond yield settled at 6.53%, 5 bps lower than September. “While short and mid-term yields softened, the longer end remained under pressure, reflecting continued market discomfort with demand-supply dynamics,” he explained.

Pal believes the RBI may need to go beyond verbal support to stabilize the long end of the curve. “There are growing expectations that the central bank could start conducting Open Market Operation (OMO) purchases, especially as liquidity tightens due to FX interventions,” he said.

INR Near Record Low; FPI Flows Support Bonds

The rupee ended October at 88.77 per USD, near its all-time low of 88.80, despite active RBI intervention. However, foreign portfolio investors (FPIs) remained net buyers in the bond market, bringing in USD 1.97 billion in October and USD 8.16 billion year-to-date, in contrast to persistent FPI outflows from equities.

Short-term money market rates also reflected tightening liquidity, with 3-month CDs trading around 6.00–6.05% and 1-year CDs between 6.40–6.50%. Meanwhile, the Overnight Indexed Swap (OIS) curve flattened slightly, with the 5-year OIS yield easing to 5.67% and the 1-year OIS rising marginally to 5.47%.

Global Softening in Yields but End of Rate Cycle Near

Globally, bond yields softened as the US Federal Reserve trimmed policy rates once again, although Chair Jerome Powell refrained from committing to further cuts in December. “The US yield curve also steepened, reflecting the same caution seen domestically,” Pal noted.

Looking ahead, Pal expects the RBI to begin OMO purchases next quarter to offset shrinking liquidity from rising currency circulation and sustained FX intervention. “The bond market is beginning to accept that we are at the end of the rate-cutting cycle, though there may still be room for one more rate cut,” he added.

Outlook: Range-Bound Yields, SDLs to Outperform

“We expect yields to remain range-bound, with the 10-year benchmark trading between 6.30% and 6.70% over the next couple of months,” said Pal.

He believes State Development Loans (SDLs) are likely to outperform over the medium term, given their relatively attractive spreads and lower supply in the near term.

“Despite near-term volatility and liquidity tightness, India’s bond market remains well-supported by easing inflation, healthy macro fundamentals, and strong FPI participation,” concluded Puneet Pal.

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