Mumbai: Longer-tenor bonds are once again finding favour in India’s sovereign-debt market as a drop in inflation to a record low spurs expectations of an interest-rate cut.

Investors have earned 3.3 per cent on notes due in 10 years or more so far in June, the best total return among different maturity baskets, an analysis of the Bloomberg India Local Sovereign Bond Index shows. Securities due in one-to-three years have returned 0.5 per cent, while those in three-to-five year segment have delivered 0.8 per cent.

“The case for a bull flattening of the yield curve seems to be underway,” said Lakshmi Iyer, Mumbai-based chief investment officer for debt at Kotak Mahindra Asset Management Co, indicating the potential for long-end bond yields to fall more than those on short-term debt. “A fairly benign inflation outlook doesn’t warrant too high a premium at the longer end.”

Investor sentiment had taken a hit in April when minutes of the Reserve Bank of India’s policy meeting flagged concerns about inflation, with one of the decision-making panel’s members even calling for a pre-emptive increase in borrowing costs. However, with price gains easing at a faster pace than economists’ projected and data showing a surprise slowdown in first-quarter growth, the RBI’s tone has gone from hawkish to dovish in a matter of weeks.

The authority on June 7 pared its inflation forecast to 2 per cent to 3.5 per cent for the first half of the fiscal year ending in March, down from 4.5 per cent previously, even as it left the benchmark repurchase rate unchanged. Consumer-price gains slowed further to a record low of 2.18 per cent in May, data showed Monday, bolstering expectations of easing.

The central bank would work for a broader accommodation through the interest-rate policy if data so warrants, Deputy Governor Viral Acharya said at the post-policy press conference. With some analysts expecting a rate cut as early as August, the benchmark 10-year bond yield fell 11 basis points over June 7 and June 8 and slipped further this week to a four-month low.

In comparison, the 15-year yield slid 19 basis points in the two days, the 30-year yield declined 17 basis points, while that on notes maturing in three years fell 10 basis points. The recent outperformance of longer-maturity bonds marks the reversal of a trend seen earlier in the year.

“The market has started pricing in an August rate cut, and hence the performance of the longer end has been better, causing the yield curve to flatten,” said Shailendra Jhinghan, chief executive at Mumbai-based ICICI Securities Primary Dealership Ltd, one of India’s biggest bond houses. “This trend can continue as the market continues to believe that there could be deeper rate cuts going forward.”

The curve should bull-flatten until the RBI actually delivers the cut, he added. Kotak’s Iyer said she prefers the 15-year-and-above segment of the curve, where there’s a “potential for value unlocking.”

Auction demand

Meanwhile, global funds have been piling into rupee debt. Foreign holdings of government and corporate notes have climbed Rs212 billion ($3.3 billion; Dh12.06 billion) this month through June 15, on track for a fifth straight monthly increase that will be the longest run since 2015.

Rising interest in longer bonds was also evident at an auction of sovereign notes on June 9. Securities due in 2046, the longest maturity debt on offer at the sale, drew a bid-to-cover ratio of 7.9 times, more than double of what was seen at a May 26 auction.

“Duration gains are arguably best captured away from the benchmark 10-year bond,” said Sameer Goel, Deutsche Bank AG’s head of Asia macro strategy in Singapore. “The dovish bias in RBI’s latest statement, a seemingly benign ‘go slow’ global central bank approach to policy normalisation, and a carry and growth friendly liquidity backdrop — all argue bullishly for the yield curve in India over the next few months.”