Is the rally over in long-duration bonds?

After delivering stellar returns over the past 12–15 months, India’s long-duration government securities may have reached the fag end of their rally, according to Axis Mutual Fund’s Acumen report dated July 31, 2025.

The sharp gains were driven by falling yields and narrowing spreads, aided by macroeconomic easing, fiscal discipline, and favourable demand-supply dynamics.

The three drivers of the rally

Axis MF notes that the surge was underpinned by:

• Macro slowdown and policy easing – Slowing GDP growth in 2024 prompted the Reserve Bank of India (RBI) to front-load rate cuts, culminating in a surprise 50 bps cut in June 2025 alongside a 100 bps CRR reduction.
  
• Fiscal consolidation – The fiscal deficit fell from 9% at the COVID peak to 4.4%, with stable borrowing levels boosting market confidence.
  
• Tactical demand-supply tailwinds – RBI’s Rs 5 lakh crore in OMO purchases and US$22 billion of FPI inflows—especially after JP Morgan’s index inclusion—spurred demand for long bonds.
  

Why the rally may be nearing its end

The report argues that these catalysts are losing steam. The RBI has shifted to a neutral stance, leaving room for at most one or two small rate cuts. Fiscal consolidation is likely to plateau due to slower growth, the upcoming 8th Pay Commission, and potential declines in RBI dividends. On the demand side, OMO purchases have paused, liquidity is already in surplus, and FPI flows have turned negative over the past four months.

Demand-supply mismatch looms

Axis MF highlights that in FY26, gross long-bond supply is expected to far exceed demand. Regulatory changes—such as revised Held-to-Maturity limits for banks, higher equity limits for NPS, and restrictions on FPI investments beyond 14 years—are further reducing appetite for long-duration paper.

Spreads and historical context

Long-bond spreads over 10-year G-Secs have already widened by 54 bps in the current cycle, close to levels seen at the end of previous rate-cut cycles. The report also notes that 30-year G-Sec yields rarely fall below 6.75%, suggesting limited scope for further price gains.

Investor strategy

According to Axis MF, “the primary concern for long-duration bonds is no longer about spreads or yield levels—it lies in the deteriorating demand-supply dynamics.” Unless there’s a major growth shock triggering aggressive rate cuts, or renewed foreign interest from Bloomberg index inclusion, the scope for a further rally appears limited.

The fund house advises real-money investors with long-term liabilities to consider long bonds only if they can stomach short-term volatility. For most others, the steepening yield curve makes 2–5-year corporate bonds a more attractive risk-reward bet. Tactical opportunities in long bonds may still offer 10–15 bps of upside, but these are likely to be short-lived.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of the Economic Times)