As we write this, India witnessed two important events – namely the presentation of the Union Budget for 2026-27 and the progress on the India-US trade deal. The Union Budget, in a nutshell, ensured policy continuity and conveyed a reasonably conservative stance focussing primarily on fiscal consolidation, laying the building blocks for long-term growth and employment generation and continuing to support public expenditures in critical areas such as defence and infrastructure. 

The Indo-US trade deal (though not fully concluded) appears to be moving forward and has the potential to lift some of the near-term growth challenges for the economy especially in export-driven sectors. This likely strengthens our argument of a cyclically stronger phase of corporate earnings in FY27 and beyond.

As we begin 2026, we also potentially see mean reversion of few other trends as well: 1. Likely return of inflation as geo-politics bear upon hard commodities including oil

1) Consequent bottoming of the interest rate cycle and

2) Stabilisation of the INR

While global market conditions especially the US, remain conducive overall, the recent softening of the technology and AI trade, open up an opportunity for global investors to rotate into diversified markets such as India for global investors. Besides the impact of pass-through inflation from tariffs and slowing labour markets may be fully felt in 1H2026. We thus expect global equities to take a pause in early 2026. Returns on precious commodities like Gold/Silver could potentially slow especially if the US dollar gains lost ground.

The 2QFY26 earnings season in India seems to be unfolding better than expectations compared to the past 4 quarters and the earnings downgrade cycle appears to have bottomed out thanks to the recent measures on taxation and falling inflation.

We expect the market opportunities in India to operate at the two ends of the barbell. Large-cap biased strategies may prevail supported by earnings revision. On the other hand, we see smallcaps providing a good opportunity to accumulate given their sharper underperformance within the overall market and a likely rebound once the domestic economic cycle enters a period of greater strength towards latter part of FY27. We also strongly advocate investors form a credible allocation to multi-asset strategies from a longer-term standpoint as the best possible defence to global asset class volatility and to enhance overall quality of investment returns.

CY2025 ended on a weaker note as global yields jumped by 15-20 bps during the December month, triggered by Japan’s rate hike and a hawkish commentary by few Developed market Central banks. Even as US’s inflation data for November came much better than the market expectations, it failed to provide relief as the market doubted the data reliability amidst the US’s Govt shutdown. Domestic G-Sec yields also hardened by 5-10 bps with a flattening bias, despite the RBI’s 25 bps policy rate cut. INR remained under pressure and crossed 91 for the first time against dollar as US-India trade deal remained elusive and heavy foreign outflows from both debt & equity segment. Corporate bond issuance remained low in December as few issuers were forced to cancel the auction due to higher bids.

Outlook

CY2026 is expected to be a challenging year for global Fixed income Markets. After delivering steep rate cuts in CY2025, many countries are now towards the end of their rate cut cycle with few countries even expected to hike the rates in CY2026. Many countries have adopted an aggressive fiscal expansionary policy, especially in the light of rising geo-political tensions. Geopolitical tensions around trade and strategic alliances remain important tail risks for global bond markets, feeding directly into US Treasury and EM local currency curve pricing.

Indian fixed income market is expected to be no different and bound to be volatile. RBI has already cut the policy rate by a cumulative 125 bps in CY2025. While the current inflation trajectory remains very benign and opens up a space for one more rate cut, any such likelihood will largely depend upon the economic growth slowdown. On the fiscal front also, after achieving a very fast paced fiscal consolidation since pandemic, further pace of consolidation is expected to be moderate only as the Central Government targets to reach Debt / GDP of 50% by FY31 from the current ~56%. State borrowings for 4QFY26 has come higher than market expectations. Gross borrowing of both Central Govt and States is expected to be ~Rs 30 trillion in FY27 and will test the market appetite.

Nonetheless, we maintain our constructive view on domestic fixed income market as we expect the yields to decline in 1HCY2026 from the currently elevated levels. We believe the current yields are not reflecting the policy rate cuts done so far & RBI’s pro-active liquidity management approach and has over-reacted to the domestic supply concerns. Current 10 yr G-Sec yield at ~6.60-6.65% gives 135-140 bps term spread over the 5.25% repo rate, such spreads are only seen during the past rate hike cycle. With the current inflation running low at ~2% for FY26, the real yields are quite elevated at more than 4.5%, making the risk-reward favourable. Although early to conclude, even FY27 inflation is also expected to remain benign and closer to the 4% mark, giving room to RBI to keep policy rates lower for longer. RBI’s December MPC cut the repo rate by 25 bps to 5.25%, with members unanimously supporting the move while keeping the stance broadly neutral. The MPC lowered its FY26 CPI projection by 60 bps to 2% and upgraded growth to 7.3%, underlining that broad based disinflation has created room to support activity. Minutes and post policy commentary show members increasingly focused on growth risks as both headline and core inflation remain comfortably contained. While the supply overhang will remain a concern, we expect RBI to conduct more Open Market Purchase Operations (OMOs) of G-Sec over Feb / March 2026 and even in FY2027 which will recede the market concerns to an extent. RBI has made its intent clear by announcing substantial durable injections through OMO purchases and FX swaps, including plans to buy up to about `2 trillion G-secs and conduct 10-billion-dollar USD/INR buy-sell swaps. If the sovereign bonds get included in Bloomberg Global bond index, it will further support the demand-supply dynamics. Market sentiments can also turn positive if US – India reach to a tariff trade deal, triggering foreign inflows in domestic market.

Considering the risk-reward, we believe actively managed short-term funds and corporate bonds funds with balanced exposure towards 2 – 4 yr corporate bonds and 5-10 yr G-Sec provides suitable opportunities for core allocation in CY2026. At the same time, funds like money market and Low Duration funds provide high carry without much of volatility. Additionally, even though with a risk of higher volatility, one can look at the Gilt funds as a tactical call given that the term spreads have jumped sharply higher. Amidst higher volatility, active duration management across the curve and selective credit for higher carry is likely to offer better risk adjusted outcomes.