Why fixed-income investors should shift focus from duration to yield in 2026, says Shriram Ramanathan

Kshitij Anand: Well, the benchmark 10-year yield ended at 6.5% in 2025. What I wanted to understand is that it marks the third consecutive year of decline. How should investors interpret the limited downside in yields?

Shriram Ramanathan: Clearly, as you said, we have seen the RBI cut rates by almost 125 basis points in this calendar year. However, government bond yields have come down by a very limited 15 to 17 basis points. You have to remember that markets are always forward-looking.

If you look at what happened in calendar year 2024, the 10-year G-Sec was at around 7.25% at the start of the year and ended December 2024 at about 6.75%. So, in anticipation of rate cuts, markets had already rallied, with interest rates on government bonds lower by around 50 basis points.

Subsequently, this year as well, until about June, we saw yields fall further—from 6.75% to almost 6.25%, which was another 50-basis-point rally. So, in total, yields moved nearly 100 basis points over one-and-a-half years.

Live Events

However, as we near the end of a rate-cut cycle, markets start sensing that. From June onwards, we have seen a retracement in yields. Interest rates moved up from the low of 6.25% in June to around 6.50–6.60%, as you mentioned. This is typical. If you go back in time and look at the four rate-cutting cycles over the last 20 years, well before the final rate cut, markets start anticipating when the next hike might happen, and that begins to influence yields.

That said, this time is somewhat different from previous cycles. Even after these rate cuts, inflation remains low, oil prices are benign, and global inflationary pressures are not very significant. Domestically as well, with actions taken by the government, forward-looking inflation appears reasonably controlled. Unlike earlier cycles, I do not see a sharp pullback or fears of a sharp rise in rates. Instead, we are likely to see consolidation and stabilisation around current levels.

Kshitij Anand: In an environment where rate cuts are largely behind us and the RBI is in a neutral stance, which segments of the fixed-income market—sovereign, corporate, or credit—do you find most attractive?
Shriram Ramanathan: The starting point is that we are closer to the end of a rate-cutting cycle, and that should influence how much risk investors take. This is a phase where interest-rate risk, measured in terms of portfolio duration, should generally be low to moderate.

As we are at the end of the rate-cut cycle, interest rates may be more volatile, and over the next two years, the gradual trend is likely to be slightly higher. There may be tactical opportunities in certain segments, but structurally and fundamentally, portfolios should have lower duration and relatively lower risk, while benefiting from select dislocations.

One such opportunity is state development loans (SDLs). There has been considerable focus on them due to the massive supply. In the January–March quarter, we are likely to see nearly ₹5 lakh crore of SDL issuances. This has led to spreads over government securities widening. We expect this trend to continue over the next month or so.

Currently, spreads on the 10-year SDL are close to 80 basis points. If they move closer to 100 basis points, we believe those levels are quite attractive, offering potential for spread compression over a three- to six-month horizon. These are, of course, riskier trades, and investors should be mindful of that. But for those with the required risk appetite, such opportunities do exist.

Another segment is two- to three-year corporate bonds. Two years ago, corporate bond spreads were as low as 25 basis points over government bonds. Today, they have widened to nearly 100 basis points. This means investors can earn close to 100 basis points over government securities in AAA PSU bonds in the two- to three-year segment. Duration risk remains low, while yields are attractive.

These segments are appealing for investors who want to keep risk low but still earn better returns compared to liquid or overnight funds. This is where we expect investor interest and flows to gradually move.

Kshitij Anand: And there is another thing which grabbed the headlines in the year 25 was the rupee. In In fact, it weakened sharply in 2025, moving closer to 90. What I wanted to understand is that the rupee has also been exerting pressure on bond sentiment. How critical will currency stability be in shaping foreign and domestic investors’ interest in the Indian debt market in 2026? I ask this because now that we have touched 90, there are growing expectations and debates around whether the rupee could move towards 100.
Shriram Ramanathan: Clearly, ever since the tariff-related developments began in July, the rupee has been a key focus for various markets, especially fixed-income markets, because currency and fixed income are closely linked in many ways. That said, we must differentiate between what is happening with the rupee now and what happened in 2013–14. That period saw genuine stress in India’s macroeconomic parameters, and the rupee reflected that fragility.

Today, the situation is somewhat the opposite. Our underlying macroeconomic strength is arguably at its best. Growth is close to 7–7.5%, inflation has been benign for a long time and is clearly below 4%, and overall economic indicators remain healthy. While there is always room for improvement, India’s macroeconomic scorecard remains fairly positive.

Despite this, the rupee has reacted in a particular way, largely due to tariff-related developments. To some extent, this has also acted as a policy lever used by policymakers to respond to and manage the challenges arising from tariff announcements. In that sense, it is a response to the situation and not necessarily a negative signal. It is something markets need to get used to.

Importantly, since this is not a sign of macroeconomic weakness, once the uncertainty clears—whenever that happens—the rupee could see a reversal or appreciation. That is typically how catch-up moves driven by valuation play out. For now, given the uncertainty, it is reasonable to assume a gradual depreciation trend, and investors need not worry excessively.

As far as fixed-income markets are concerned, while the rupee has had some impact, it has not been very significant. The effects have largely been temporary, though it is something we are monitoring closely.

Another important factor for the rupee is the potential global bond index inclusion for India. While the negatives are well known, this is a meaningful positive that could materialise as early as the coming quarter. If it does, it could lead to inflows of around $15-20 billion into Indian bond markets over the course of FY27. Given that the rupee is fairly undervalued, any positive news on this front could help stabilise or even reverse the current trend.

Kshitij Anand: In fact, because the rupee has depreciated, another factor that has helped the Indian economy is lower crude oil prices, which have not spiked in recent times. This has supported the current account deficit and prevented it from worsening. Against the backdrop of trade tariff wars, can global developments such as US Fed policy, trade negotiations, or a potential India–US deal meaningfully affect Indian yields and capital flows in 2026?
Shriram Ramanathan: Without a doubt, global developments—especially those related to tariffs—will be significant. However, the bar for such news to be materially positive is quite high. For it to be a true macroeconomic game changer for India, we would need a trade deal that places us at the lower end of the tariff spectrum globally, not just a partial rollback of penalties.

In practical terms, this would require effective tariffs of 20% or lower, which seems somewhat unlikely. What is more realistic is some easing of pressure, perhaps bringing tariffs down from 50% to around 25–30%. While that would offer relief to markets, it would still leave India at a relative disadvantage and would not fundamentally alter the country’s macroeconomic outlook.

That said, any easing would be a relief, particularly for the rupee, which has borne much of the adjustment burden. As and when the pressure eases, some retracement or recovery in the rupee is likely.

For fixed-income markets, however, the impact of tariffs is likely to remain limited. The adverse impact on growth has been minimal, and since there was no significant growth slowdown, the potential upside from tariff relief is also limited. As a result, the effect on fixed-income markets is relatively muted.

Regarding Fed policy, that remains a key global driver. US Treasury markets have been relatively stable, and the rate cuts signalled by the Fed are largely priced in. The key risks lie in potential surprises—whether related to the size of global debt issuance or unexpected moves in inflation, either higher or lower.

Given that most emerging markets have already used much of their monetary policy ammunition over the past year, further easing would require the Fed to move beyond what is currently priced in. That is not our base case. This is also why we believe India is nearing the end of the road when it comes to policy rate cuts.

Kshitij Anand: How should portfolio managers position duration and credit exposure, given the expected heavy issuance by central and state governments in the coming year—a point you have already highlighted earlier in our conversation?
Shriram Ramanathan: As I mentioned earlier, this is a time to be a bit more prudent and cautious with duration across portfolios, and the same applies to investors as well. Broadly speaking, over the last one to one-and-a-half years, we have generally maintained a higher duration bias—we were probably overweight compared to peers and benchmarks. Now, I think it is time to move closer to neutral or even gradually go underweight on duration positioning within each category. That is the overarching factor.

Within this framework, however, tactical opportunities will continue to emerge. To name a few, during January, February, and March, liquidity typically tightens, leading to higher money market rates, particularly bank certificate of deposit (CD) rates. We are already seeing this happen. Many times, these moves reverse quickly as we enter April. This creates an opportunity in six-month to one-year bank CDs, which money market funds typically invest in. From a near-term perspective, this offers a good opportunity to capture incremental returns.

Similarly, as mentioned earlier, state development loans (SDLs) present another tactical opportunity. This is a dislocated market where spreads are wide and may widen further, creating scope to benefit from a potential reversal. These tactical ideas can be overlaid on top of the overall cautious stance on duration.

Beyond this, investors need to remain mindful of the evolving environment, as opportunities can open up unexpectedly. But as things stand, being near the end of the rate-cut cycle, staying cautious on duration, and selectively using tactical opportunities in SDLs and money market instruments should be the broad approach for the coming year.

Kshitij Anand: My next question is about mistakes investors may have made in 2024–25. How should investors approach 2026 differently, and what should they avoid this year?
Shriram Ramanathan: Broadly speaking, both 2024 and 2025 have been reasonably pleasant years for fixed-income investors, as yields across most segments have declined. If anything, investors may not have participated as aggressively as they could have, largely because other asset classes performed well during this period. Overall, the last two years have been good for fixed income.

Looking ahead, this year is more likely to be a year of consolidation. We do not expect significant capital gains, which means the focus should shift towards portfolio yields. Incorporating a measured amount of credit exposure makes sense, ensuring investors earn adequate returns without taking excessive interest-rate risk or volatility.

Low-duration funds, money market funds, and short-duration funds—being less sensitive to interest-rate movements—are areas I would focus on. The idea is to ensure portfolio yields remain attractive while selectively adding credit exposure in a controlled manner. The credit environment continues to be very favourable—arguably better than it has been in a long time. Bank balance sheets and corporate balance sheets are in strong shape, which creates opportunities to enhance yields through selective exposure to AA-rated instruments. That, broadly, would be the playbook.

Kshitij Anand: If yields remain anchored around current levels, what should be the rule of thumb for fixed-income investors entering 2026?
Shriram Ramanathan: Broadly, the rule of thumb is that yields are likely to inch slightly higher from current levels. Over a one- to two-year horizon, rates are probably going to be somewhat higher than where they are today. The key is to avoid getting caught on the wrong side of rising rates and suffering unnecessary capital losses.

This is very different from the approach over the last two years, which was focused on capturing capital gains. Now, the emphasis should be on being cautious and measured. Dislocations will continue to appear, and investors who have the ability should look to selectively participate in opportunities such as SDLs.

Overall, the main rule of thumb is to play it safe—focus on credit-oriented and accrual strategies rather than taking aggressive duration or interest-rate-sensitive positions.