In conversation with Marzban Irani, President - Fixed Income Strategy, LIC Mutual Fund Asset Management Ltd.

With the U.S. Federal Reserve maintaining its policy rate and indicating a higher inflation outlook, what do you expect the RBI’s stance to be, and implications for India’s fixed income market?

The Reserve Bank of India is expected to maintain a cautious, data-dependent stance and remain on pause, as it would be premature to signal any shift in the domestic monetary outlook. Forward guidance is likely to emphasise caution, particularly amid the risk of upward revisions to inflation due to rising energy prices. On liquidity, the Governor is expected to reiterate supportive measures, given the large government borrowing programme and firming short-term rates. For fixed income markets, this points to a largely range-bound yield environment. However, in absence of global flows, the demand-supply equation is firmly tilted towards supply. The shorter end of the curve should remain supported, given the historic high spreads.

With the rupee witnessing increased volatility, what could be the impact on bond yields and investor sentiment?

Currency volatility typically tightens financial conditions as it raises concerns around imported inflation and capital outflows. In such an environment, bond yields tend to face upward pressure, particularly at the shorter end of the curve. However, India’s strong foreign exchange buffers help mitigate sharp dislocations. From an investor standpoint, volatility may lead to a preference for high-quality assets and shorter-duration strategies in the near term, while long-term investors could view any sharp yield spikes as opportunities to add duration.

What is your current duration strategy, and how are you positioning portfolios across the yield curve?

We are currently maintaining a moderately positive duration stance across our bond funds, with allocations to money market instruments and 1-3-year corporate bonds complemented by exposure to the ultra-long end of the sovereign curve. On a quarterly basis, overall portfolio duration has been reduced. Given elevated volatility, we have adopted a more tactical approach to duration management rather than a one-sided positioning. The shorter end of the curve continues to provide stability and carry, while long-dated sovereign bonds appear reasonably priced at current levels to offer duration exposure.

Within shorter-duration and money market schemes, positioning remains on the higher side, largely reflecting year-end tightening and redemption pressures. We expect yields in this segment to ease by 25-35 bps, with one-year CDs likely to move below the 7 per cent mark. The yield curve is also expected to remain well bid at prevailing spreads and absorb incremental system flows.

How do you evaluate credit risk in the current cycle, and are there specific sectors you are cautious or optimistic about?

Credit fundamentals in India remain broadly stable, supported by deleveraged corporate balance sheets and a robust banking system. Our preference continues to be for high-quality AAA to AA issuers, with an emphasis on sectors exhibiting resilient cash flows. In light of recent market volatility, we remain cautious on highly leveraged balance sheets where the impact of higher interest rates is yet to fully materialise. Disciplined credit selection remains critical in the current geopolitical environment.

What key risks should fixed income investors watch out for in the coming months?

Key risks include a renewed uptick in global inflation driven by supply-side shocks, which could disrupt the current easing bias. Sharp volatility in the rupee or unexpected domestic fiscal slippage could also exert upward pressure on bond yields. Additionally, evolving global and domestic liquidity conditions may remain critical variables to monitor.

What kind of fixed income allocation strategy would you recommend for retail investors in the current environment?

The focus should remain on high-quality portfolios to minimise credit risk. Given prevailing spreads in money markets and the 1-3-year AAA corporate segment, this part of the curve may offer risk-adjusted returns. While it is premature to call an end to monetary support, a deterioration in macro conditions could prompt rate hikes earlier than currently anticipated.