India's Government Bonds Ahead of the RBI Rate Decision: Strategic Yield Curve Positioning Amid Rate Cut Expectations

The Reserve Bank of India's (RBI) June 2025 monetary policy decision is poised to reshape India's government bond market, with traders and investors facing critical choices between shorter- and longer-duration instruments. With rate cut expectations of 25-50 basis points (bps), waning demand for ultra-long bonds, and the potential for post-policy inflows, the yield curve offers a compelling opportunity for strategic positioning. Let's dissect the dynamics and outline actionable strategies.

Current Yield Curve Dynamics: A Flattening Play

As of early June 2025, the 5-year bond (6.75% 2029) yields 5.8461%, while the 10-year benchmark (Tamil Nadu 2035) yields 6.1966%. This 35-basis-point spread reflects a flattening curve, with the RBI's accommodative stance compressing longer-term yields. The 30-year bond (7.09% 2054), however, still commands a higher yield of 6.8537%, indicating persistent demand for shorter-to-mid-term maturities.

The key opportunity lies in the expectation that the RBI's rate cut will disproportionately benefit longer-duration bonds. A 25-bps reduction in the repo rate to 5.75%—or even a “jumbo” 50-bps cut—will likely drive a steeper decline in yields for 10-year and longer securities compared to shorter tenors. This is because long-term yields are more sensitive to policy expectations and liquidity conditions.

Rate Cut Expectations: Yield Compression in Focus

Analysts widely anticipate a 25-bps cut, but some, including the State Bank of India, advocate for a 50-bps reduction to combat global uncertainties. Either outcome will accelerate yield compression, particularly in the mid-to-long end of the curve.

• Scenario 1 (25-bps cut): The 10-year yield could drop to 6.1% or lower, while the 5-year might fall to 5.8%. The spread could narrow to 30 bps or less.
• Scenario 2 (50-bps cut): The 10-year yield could plummet to 6.0%, with the 5-year at 5.75%, compressing the spread further to 25 bps.

Investors in 10-year bonds stand to gain the most from this compression, as their prices rise more sharply when yields decline.

Liquidity Trends: Surpluses and Post-Policy Inflows

The RBI's liquidity measures—$100 billion injected into banks since December 2024—have created a system surplus of ₹1.5 trillion, stabilizing short-term rates. However, the real catalyst for long-end performance will be post-policy inflows, including:

1. Domestic Re-allocations: Mutual funds and insurance companies, which dominate bond market participation, may shift into longer durations to lock in higher yields before further cuts.
2. Foreign Portfolio Inflows: While April saw $1.6 billion in outflows due to global trade jitters, a dovish policy outcome could reverse this trend. The inclusion of Indian bonds in global indices (e.g., J.P. Morgan's GBI-EM) remains a tailwind.
3. RBI's OMO Support: Open Market Operations (OMOs) targeting mid-to-long tenors will reinforce liquidity, reducing rolldown risk for holders of longer bonds.

The Case Against Ultra-Long Duration: Liquidity Risks

While the 30-year bond's 6.85% yield may seem attractive, its lower liquidity makes it a risky bet. Post-policy, traders may prioritize mid-term maturities (5–10 years) over ultra-long instruments. The 10-year bond's balance of yield and liquidity makes it the optimal sweet spot.

Investment Strategy: Shift to 10-Year Bonds

• Sell Short-Term (5Y) for Long-Term (10Y): Traders should consider swapping 5-year holdings into 10-year bonds. The yield pickup of ~35 bps (5.84% vs. 6.19%) offers a cushion against potential rate cuts.
• Bull Flattening Trade: Buy 10-year and sell 5-year bonds to profit from narrowing spreads. This strategy capitalizes on the expectation that longer yields will fall faster than shorter ones.
• Hold Until Policy Announcement: Avoid front-running until the June 6 decision. Once the cut is confirmed, scale into longer tenors to capture post-policy inflows.

Conclusion

The RBI's June policy is a pivotal moment for India's bond market. With rate cuts likely and liquidity conditions supportive, investors should prioritize 10-year government bonds to maximize yield compression gains. The flattening yield curve, combined with post-policy inflows, creates a rare alignment of factors favoring mid-to-long-term positions. Traders who tactically shift allocations to the 10-year tenor stand to benefit most from this strategic opportunity.