High Bond Yields: Where to Invest in Debt Funds Now?

Even after the Monetary Policy Committee (MPC) signalled a dovish stance early in the month, bond markets stayed cautious, and yields continued to rise through December 2025. This was unusual.

“Bond yields continued their upward trajectory in December 2025 in spite of a dovish MPC policy earlier in the month, as bond markets continue to grapple with adverse demand/supply dynamics,” says Puneet Pal, Head- Fixed Income, PGIM India Mutual Fund.

The RBI attempted to ease liquidity through multiple steps, by announcing Rs 1 lakh crore of Open Market Operations (OMO) purchases and a $5 bn USD-INR swap early in the month. Still, yields rose across the curve, although the longer end was relatively protected as value buying emerged.

The benchmark 10-year bond yield rose 8 basis points from the start of the month to end at 6.59 per cent, after touching a high of 6.67 per cent. Pal notes that “yields rose across the curve, though the longer end of the curve was spared as value buying kicked in.”

Rupee volatility also weighed on bond market sentiment. The currency depreciated sharply to touch an all-time low of 91.03 against the dollar, before closing the month at 89.88. The RBI stepped in to smoothen volatility, combining incremental OMOs of Rs 2 lakh crore with a $10 bn USD/INR swap, after which yields moderated. Yet the cautious tone has not fully faded. Pal says, “Even after the announcement of OMOs and USD/INR buy-sell swaps, the bond markets remain quite cautious.”

Despite 125 bps of policy rate cuts and over Rs 6 lakh crore of OMO purchases in  calendar year 2025, bond yields have remained sticky. The 10-year yield has fallen only 20 bps, while the 40-year yield has risen 25 bps. Liquidity conditions, as per Pal, have also tightened meaningfully, with a durable banking system liquidity surplus dropping from Rs 5.84 lakh crore in May 2025 to Rs 2.60 lakh crore as of November 2025.

On the macro front, CPI inflation stood at 0.71 per cent, with “core” CPI steady at 4.4 per cent, while “core core” inflation excluding gold softened to 2.40 per cent. Pal expects CPI inflation to hover near 4.00 per cent in FY27, which could keep the RBI on an elongated pause. External balances improved somewhat, with the trade deficit narrowing to $24.50 bn in November from $42 bn in October due to a sharp fall in gold imports.

Looking ahead, Pal expects the 10-year benchmark yield to trade in a 6.40 per cent to 6.75 per cent range over the next couple of months, with markets closely tracking the supply of state government securities (SGS) next quarter.

Given these conditions, Pal’s investment approach stays conservative and maturity-focused.

“Investors can continue to allocate to Corporate Bond Funds having portfolio maturity up to 3 years while being tactical in their allocation to duration through Dynamic Bond Funds,” Puneet Pal advises.

He adds that investors should have a minimum horizon of 12–18 months, while short-term investors may also consider up to 1-year money market yields, which appear relatively attractive on risk-reward. “We expect a long pause on policy rates and accruals to be the major factor in overall fixed income returns next year,” Pal concludes.