Debt mutual funds: Axis MF suggests where to invest as RBI may raise rates by 50-75 bps over next 6 months

Debt mutual fund investors may need to reassess where they park their money as interest rates show signs of staying higher for longer. Rising bond yields can put pressure on existing bond prices and, in turn, affect returns from debt funds, particularly those with longer maturities.

Against this backdrop, Axis Mutual Fund, in its report, noted that the US Federal Reserve raised the federal funds rate by 25 basis points to 3.75%-4.00% at its September 2026 FOMC meeting. The move comes after a period of nearly three years in which investors navigated relatively stable or declining interest rates.

More importantly, the Fed’s updated projections suggest that this may not be a one-off move, with policymakers signalling the possibility of additional hikes, which could mark a shift towards a “higher for longer” interest rate environment.

The report examines how this changing global rate cycle could affect Indian bond yields and where investors could find opportunities as the RBI’s own rate cycle evolves.

Should debt fund investors worry about rising interest rates?

Historically, a Fed hiking cycle has transmitted to India through three channels: pressure on the rupee, higher domestic bond yields and greater external vulnerability, according to the report.

The same distinction is important for Indian bond yields. Global yields can create bouts of volatility, but Axis MF mentioned that more persistent upward pressure on Indian yields is likely to come from domestic factors rather than simply from higher US Treasury yields.

The report also noted an immediate market reaction, with the 10-year government bond yield moving above 7% following the Fed hike.

Axis MF expects the RBI to undertake a “measured tightening cycle of 50-75 bps over the next 6 months”, taking the operative policy rate towards 6%-6.25%.

If the RBI raises rates, bond yields could rise, and existing bond prices could fall, which can create pressure on debt mutual fund returns, especially long-duration funds.

For investors, near-term pressure on bond yields could create opportunities to gradually lock into attractive yields as the tightening cycle progresses, it noted.

Which debt mutual funds does Axis MF prefer now?

Axis MF is overweight on 1-3 year corporate bonds while cautious on long SDLs, or state development loans.

For investors, this points towards the 1-3 year corporate bond segment, where the fund house sees an attractive risk-reward balance because of “favourable carry, ample liquidity and limited CD issuance”.

This could translate into considering short-duration funds or corporate bond funds, depending on the portfolio’s maturity and credit quality.

The report noted that “the fixed income opportunity remains attractive, but selectivity is key.”

What about long-duration debt funds?

Axis MF remains neutral on government securities for now and cautious on long-duration state development loans (SDLs).

The report expects RBI measures such as OMO sales to absorb surplus liquidity, while higher fiscal slippage risks and the deferment of Bloomberg index inclusion could keep yields under pressure.

It says elevated state borrowing and an unfavourable demand-supply balance could keep long SDL yields elevated. Risks from the 8th Pay Commission, softer tax collections and subsidy pressures also warrant caution.

For government securities, however, Axis MF said that as the rate-hiking cycle progresses and yields are repriced higher, and given its view of a shallow interest-rate hike cycle, it suggested looking for opportunities to “tactically add duration”.

This means mutual fund investors can look to add exposure to gilt funds tactically or in a staggered manner as yields rise, while remaining cautious about funds investing in long-duration SDLs, given the risks highlighted by Axis MF.