India's Bond Market Volatility: Navigating Tactical Entry Points Amid RBI Policy Shifts and Yield Convergence

India's bond market is at a pivotal inflection point as the Reserve Bank of India (RBI) navigates a delicate balance between inflation control and growth support. With the central bank's policy pivot and liquidity dynamics creating a narrowing yield range, tactical entry points in Indian government bonds (G-Secs) are emerging for investors seeking to capitalize on this evolving landscape.

The RBI's Policy Tightrope: Accommodative to Neutral

The RBI's recent 50-basis-point (bps) rate cut in June 2025, reducing the repo rate to 5.75%, marked a shift from an "accommodative" to a "neutral" stance. This decision was driven by a sharp decline in headline CPI inflation to 2.10%—the lowest in over six years—coupled with strong economic growth projections of 6.5% for FY2025-26. However, the central bank's cautious approach reflects its commitment to maintaining price stability while supporting growth.

The upcoming MPC meeting on August 5–7, 2025 will be critical. With inflation projected to remain below the 4% target for the remainder of FY2025-26, markets are pricing in a potential 25–50 bps rate cut. This anticipation has already pushed the 10-year G-Sec yield to a range of 6.27–6.32%, its narrowest since early 2023. The flattening yield curve—driven by aggressive short-end yield declines outpacing long-end movements—signals a market recalibration to a lower-for-longer rate environment.

Liquidity Injections and Yield Compression

The RBI's liquidity injections have been a double-edged sword. Over $100 billion in liquidity has been infused since early 2025 through measures like open market operations and CRR cuts. While this has suppressed short-term yields (the 5-year G-Sec yield fell 80 bps in 2025), it has also created a mismatch in the yield curve. The 10-year yield now trades at a 36-basis-point spread to the 5-year yield, the flattest since 2020.

This compression is not without risks. A liquidity surplus of 2.4 trillion rupees as of July 2025 has tightened overnight indexed swap (OIS) rates, with the one-year OIS now at 5.49%. Traders are betting on a shallow easing cycle, with further rate cuts contingent on inflation staying below 3.5% in Q3 and Q4.

Tactical Entry Points: A Case for Long-Duration G-Secs

The narrowing yield range presents a unique opportunity for tactical entry into long-duration Indian government bonds. The 6.75% 2029 G-Sec, for example, is currently yielding 5.75%, with analysts projecting a move to 5.50% by late 2025. This 25-bps potential upside, combined with a widening 10-year/2029 yield spread (currently at 36 bps), suggests undervaluation relative to the benchmark.

Key entry criteria for tactical positions include:
1. Yield Spreads: Target bonds with spreads over 40 bps against the 10-year yield, as these offer higher carry in a flattening curve.
2. Inflation Sensitivity: Prioritize bonds with lower duration (e.g., 5–7 years) to mitigate risks from unexpected inflation spikes.
3. Policy Cues: Use the August and October MPC meetings as decision anchors. A 25-bps rate cut in August would likely push 10-year yields below 6.25%, creating near-term buying opportunities.

Risks and Mitigation Strategies

While the current environment favors bondholders, risks persist:
- Inflation Reversal: A surge in food prices due to monsoon failures or global commodity shocks could force the RBI to pause easing.
- Global Spillovers: U.S. Treasury yields, currently at 4.2%, are expected to rise on tariff concerns, creating upward pressure on Indian yields.
- Liquidity Tightening: The RBI's liquidity drainage measures could push short-term rates higher, steepening the yield curve.

To mitigate these, investors should:
- Hedge Duration Risk: Use bond futures or swaps to offset potential yield spikes.
- Diversify Maturities: Allocate 60% to long-duration bonds (7–10 years) and 40% to intermediate-term (3–5 years) to balance yield and volatility.
- Monitor Fiscal Metrics: The government's 4.4% fiscal deficit target for FY2025-26 reduces supply-side pressures on bond yields.

Conclusion: A Window for Strategic Positioning

India's bond market is entering a phase of defined volatility, with the RBI's policy pivot and inflation trajectory creating a narrowing yield range. For investors with a 6–12 month horizon, tactical entry points in long-duration G-Secs—particularly those with yield spreads above 40 bps—offer compelling risk-adjusted returns. However, success hinges on disciplined timing, active risk management, and a close watch on the August MPC meeting.

In a world where global bond markets remain fragile, India's domestic demand-driven growth and structural fiscal discipline make its G-Secs an attractive haven. As the RBI's policy clarity crystallizes, the stage is set for a strategic repositioning in Indian fixed income.