ETMarkets Smart Talk| FDs, G-Secs or debt funds? UTI AMC's Anurag Mittal explains what works in a rising-rate cycle

Bond yields are rising, liquidity is tightening and the outlook for interest rates is becoming increasingly uncertain. For fixed-income investors, the question is no longer just about returns, but also about choosing the right instrument for the evolving rate environment.

Should investors opt for the certainty of fixed deposits, the sovereign backing of government securities, or the flexibility and diversification offered by debt mutual funds?

In this edition of ETMarkets Smart Talk, Anurag Mittal, President & Head–Fixed Income at UTI AMC, shares his views on the changing dynamics in India’s bond market, the outlook for interest rates and bond yields, and how investors can position their fixed-income portfolios in a rising-rate cycle. Edited Excerpts –

Q) We have seen bond yields rise, liquidity tighten and expectations around the RBI's next policy move shift. What has fundamentally changed in India's fixed-income market over the past few weeks?

A) Three shifts have reinforced one another: tighter monetary policy, a rapid withdrawal of liquidity and a more adverse global backdrop.

Investors had expected FCNR-led liquidity to endure; instead, liquidity withdrawal and FX operations have reduced an ₹11 lakh crore surplus to marginally positive levels, with interbank liquidity expected to turn negative within the next month itself.

The RBI has used the full range of its tools to keep the rupee stable: Spot sales, sell-buy swaps, and OMO bond sales. Meanwhile, the prospect of a hawkish Fed and higher crude following Houthi attacks on Saudi Arabia have compounded pressure on bond yields, alongside concerns about geopolitical escalation after the US midterms.

The fundamental repricing is therefore markets adjusting to inflation and currency stability taking precedence over growth.

Q) Given the October 27–28 policy meeting. Looking beyond this week's meeting, what is your base case for the Fed's policy trajectory through the first quarter of 2027, and what developments could change that outlook?

A) This is an unusual cycle. Having cut its policy rate from 5.50% to 3.75% between late 2024 and mid-2026, the Fed has reversed course as inflation re-accelerated.

The current re-tightening begins at the highest starting rate since Greenspan’s 1999 cycle. It is also the first tightening cycle to begin above the Fed’s own long-run neutral estimate since it began publishing one in 2012, which allows it to restrain demand with fewer moves.

We expect a 25 bps hike in December and one further 25 bps hike by March 2027. The hawkish risk is a geopolitical escalation that lifts energy prices and extends the cycle. On the dovish side, a slowdown in AI-related spending that weakens growth could keep the Fed on hold.

Q) Could a more hawkish Fed trigger further pressure on the rupee and foreign portfolio flows into Indian debt, even if the RBI keeps domestic rates unchanged?

A) Foreign flows into Indian debt have stayed largely stable. Global allocators now treat EM debt as a separate allocation from developed-market debt, which has underperformed post Covid because of persistent fiscal slippage and higher than usual inflation.

The pressure from a hawkish Fed is more likely to come through the currency. A broadly stronger dollar would add to pressure on the rupee even if debt flows hold up.

With financial stability now central to its framework, the RBI is likely to act proactively on both liquidity and rates. That would place currency and market stability ahead of domestic inflation/growth dynamics.

For bond investors, this means a hawkish Fed would be felt mainly through tighter domestic liquidity/sharper rate hikes rather than foreign portfolio selling.

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Q) How should investors choose between fixed deposits, government securities and debt mutual funds?

A) The investor’s choice should rest on three questions: when the money is needed, how much certainty is required, and the investor’s tax position.

Fixed deposits give a known outcome on the maturity date, though interest is generally taxed annually as it accrues, and premature withdrawal typically carries a penalty.

Government securities offer sovereign credit quality and predictable cash flows if held to maturity. Selling earlier carries price risk, while coupons may have to be reinvested at lower rates, reducing the compounded return.

Debt mutual funds offer liquidity, diversification, and professional duration management, with tax on gains deferred until redemption under growth plans.

Typically, in a hiking cycle, money-market funds are appropriate, as their yields reset upward when short-term rates rise. Investors with longer horizons can ladder deposits across maturities or add bonds or duration funds gradually for horizons of two years and more.

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Q) What is your outlook for interest rates and bond yields over the next three to six months?

A) We expect a further 25-basis-point hike in December, with cumulative tightening of 75–100 basis points over this cycle, depending on food and energy prices. Tighter liquidity should push short-term yields higher than long-term yields, resulting in a bear flattening of the curve.

Over the next three to six months, we expect the 10-year government bond yield to trade between 7.50% and 7.80%, with moves towards the upper end offering opportunities to add duration gradually. The 30-year segment looks attractive at 7.90–8.00% for investors with longer horizons and the capacity to absorb interim volatility.

Our preference remains for three-year AAA-rated PSU bonds yielding around 8.25%, which offer an attractive balance of accrual and interest-rate risk. These yields appear to discount much of the expected tightening, while the segment should be less exposed to government borrowing pressures than longer-dated bonds.

Spreads also appear to price in some risk of more aggressive tightening to defend the rupee, which is not our base case.

For investors with horizons beyond 12 months, we favour building exposure gradually, anchored in the three-year segment, with selective additions to longer maturities as yields rise.

Q) What is the one fixed-income strategy investors should avoid in the current environment?

A) Investors should avoid using an instrument that does not match their investment horizon.

When yields are rising and liquidity is tightening, the costliest mistake is to place money needed within 12 to 24 months in long-duration or gilt funds just by looking at valuations in the hope of a rally. Long-end prices can stay volatile for longer than such investors can wait. A forced exit then turns a temporary mark-to-market loss into a permanent one.

Current long-end levels offer value, but only for investors with the time and appetite to hold through the cycle. Short horizons are better served by money-market and short-duration funds, where yields are resetting faster.

Q) Debt mutual funds saw outflows of ₹1.83 lakh crore in September. Should investors interpret this as a loss of confidence in fixed income, or was it largely a temporary liquidity-management phenomenon?

A) It was largely quarter-end liquidity management. Of September’s ₹1.83 lakh crore outflow, ₹1.72 lakh crore, about 94%, came from short-end categories, as treasuries drew on mutual fund balances for advance tax and other balance sheet requirements. The pattern is seasonal. June saw a ₹1.09 lakh crore outflow, reversed by a ₹1.88 lakh crore inflow in July, and October is also witnessing a recovery.

Investor participation offers another useful perspective: debt fund folios rose from 89.5 lakh in June to 97.6 lakh in September , an increase of about 9% despite rising yields. Taken together, these trends suggest temporary cash requirements were the dominant driver of redemptions.

Q) Should investors favour short-duration and money-market funds in the current environment, or does the rise in yields create an opportunity to gradually lock into longer-duration funds?

A) For most investors, it is both, in proportions set by their horizon.

Money-market and moderate duration funds like short term/corporate bond funds are well placed in a hiking cycle. Their yields can reset upward faster than the long end, improving accrual with low volatility, which makes them the right core for horizons under two years.

For investors with two years or more, current levels are closer to genuine entry point. The 10-year becomes attractive in the 7.60–7.75% zone and the 30-year between 7.90% and 8.00%.

The main risk to this view is a sharper hiking cycle aimed at currency stability, which is not our base case.

The method should be gradual: stagger allocations to gilt and dynamic bond funds over the next six months rather than timing a single entry. The peak in yields is rarely identifiable in advance, and a staggered approach removes the need to identify it.

Source: AMFI and Bloomberg

Analyst Disclaimer:

The views expressed are the author’s own views and not necessarily those of UTI Asset Management Company Limited. All illustrations/ examples are purely meant for ease of understanding of the concepts and aid in planning by the investor. All illustrations/ examples that depict future values or other estimated numbers are based on reasonable assumptions and in no way give any guarantee or assurance or indication of the future performance. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this article, will be suitable for your portfolio. Please note that past performance may or may not be sustained in future and is not a guarantee of any future returns. The reader is urged to consult his or her financial advisor before making any investment decisions. UTI Asset Management Company Limited (UTI AMC) or UTI Mutual Funds (UTI MF) along with its affiliates assumes no obligation to update or otherwise revise these estimates.

Current Outlook Disclaimer:

The views and opinions expressed in this article are based on current market conditions and available information and are subject to change.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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