US Fed Rate Cut Impact on Indian Bonds: Strategies for Debt Investors

Understanding the Fed Rate Cut Impact on Indian Bonds

The US Federal Reserve on September 18 cut interest rates by an aggressive 50 basis points (bps), raising hopes of a similar move by the Reserve Bank of India. Fed Chair Jerome Powell indicated there was more to come. "We made a good strong start and I am very pleased that we did," Reuters quoted Powell as saying at a press conference after the benchmark policy rate was reduced to the 4.75-5 percent range.

According to Siddharth Chaudhary, Senior Fund Manager – Fixed Income at Bajaj Finserv Mutual Fund, "It is clear that the worse-than-expected July employment data was the turning point. The Dot Plot indicates an additional 50 bps cut by year-end." This raises the question: what does the Fed rate cut mean for Indian debt investors?

Falling Yields and Bond Prices

Bond yields usually move in anticipation of interest rate changes. Over the past year, India’s 10-year bond yield has been on a downward trend, falling from 7.1 percent to around 6.85 percent this week. Debt market experts see the 10-year yield drifting towards 6.75 percent after September, with a year-end target of around 6.55 percent.

• When yields fall, the prices of bonds typically rise.
• Debt mutual funds holding a portfolio of bonds could see a surge in net asset value (NAV).

Dhawal Ghanshyam Dhanani, Fund Manager at SAMCO Mutual Fund, states that the Fed cut marks the beginning of a pivot in interest rates after more than four years. He emphasized that final market impacts depend on economic data such as labor rates, inflation, and unemployment rate.

Investor Strategies Post Fed Rate Cut

The Fed’s rate decision is expected to lower borrowing costs, stimulating economic activity and boosting Indian bond prices, especially long-duration bonds. This could lead to a global rally in debt markets, improving liquidity and making it cheaper for businesses and consumers to borrow.

• Long-duration funds are expected to benefit significantly from falling yields as bond prices rise.
• Short-duration funds, however, might not see the same level of gains.

Nirav Karkera, Head of Research at Fisdom, suggests increasing exposure to long-duration bonds to capitalize on potential capital appreciation. The overall situation remains bond-positive, with expectations of further rate cuts.

Impact on Fixed Deposits

Interest rates often influence fixed deposit (FD) rates. If interest rates rise, FD rates are usually hiked. Conversely, if rates are cut, FD rates may decrease. Individual banks may also consider competition and their funding needs when setting rates.

With a slew of higher-rate, limited period fixed deposit schemes set to expire soon, financial advisers recommend individuals looking for stable returns to consider locking into higher-than-regular rates.

What’s Next for RBI?

Experts speculate that the RBI may not immediately follow the Fed rate cut unless prices continue to cool. Their focus will remain on managing inflation while fostering growth. Historical trends suggest a high probability that India will follow suit with any US interest rate pivot.