As the US Fed cut rate, Indian investors must strategise their debt investments. Experts suggest focusing on gilt and corporate bond funds for potential capital appreciation, while considering individual risk and investment profiles.
As the US Federal Reserve has reduced benchmark interest rates by 25 basis points and indicated additional rate cuts in the coming months, expectations have risen that the Reserve Bank of India (RBI) will follow suit and cut rates in its next policy decision on October 1.
After delivering a larger-than-expected 50 basis point rate cut in June this year, the RBI kept the repo rate unchanged at 5.5 per cent and maintained its policy stance as “neutral” in its August policy meeting.
With the start of the Fed rate reduction cycle, the RBI has the opportunity to cut rates and further accelerate India’s economic growth without worrying much about inflation and the rupee’s weakness.
Monetary easing lowers borrowing costs, boosts consumption, and tends to cause a rally in the stock market. This raises a pertinent question about what our debt investment strategies should be during rate reductions.
Rate cuts and bonds
Like equities, central banks’ rate reduction exercise affects the debt investment landscape, including government bonds, corporate debentures, and fixed-income mutual funds.
However, for equities, it appears to be slightly complex.
Monetary easing could be both an opportunity and a challenge for debt investors. This is because there is an inverse relationship between interest rates and bond prices.
Bonds have a fixed interest rate, known as the coupon rate. When the rate is cut, newly issued bonds offer a lower coupon rate to reflect the new, lower interest rate environment.
However, for equities, it appears to be slightly complex.
Monetary easing could be both an opportunity and a challenge for debt investors. This is because there is an inverse relationship between interest rates and bond prices.
Bonds have a fixed interest rate, known as the coupon rate. When the rate is cut, newly issued bonds offer a lower coupon rate to reflect the new, lower interest rate environment.
What does this do? It makes debt investors flock to buy existing old bonds, and this increased demand drives up the market price of old bonds. When bond prices go up, yields go down because bonds’ coupon payments are fixed.
For example, suppose you buy a ₹100 bond with a 10 per cent coupon rate. You’ll receive ₹10 as interest each year. If demand pushes the bond’s market price up to ₹110, you’ll still get only ₹10 interest because the coupon is fixed. At this higher price, your effective return (yield) drops to about 9.1 per cent. That is why we say bond prices and bond yields go in opposite directions. The higher the bond price, the lower the return and vice versa.
