Why Central Bank Rate Cuts Aren’t Boosting Markets Anymore

In the last decade or so, whenever central banks have hinted at rate cuts, the stock and bond markets have gone into party mode. In fact, news of a recession or economic slowdown had markets cheering, because it would force central banks to cut rates. But this QE (Quantitative Easing) driven party is now over. Recently, global bond yields have been rising despite central banks cutting rates. 

On September 17, the US Federal Reserve slashed its policy rate by 25 basis points – resuming its rate cuts after an eight-month pause. FOMC members also indicated two more rate cuts totalling 50 basis points in the next few months. But this left the US bond markets cold, with yields staying high. 

India’s Monetary Policy Committee (MPC) has cut its repo rates by 50 basis points since June 2025 and has maintained a dovish stance. But the 10-year government bond yield has risen from 6.1% to 6.53% in the last four months. 

Rate cut news has also not helped the stock markets rally.  The Indian stock market has struggled to break out of a range despite MPC cuts. The resumption of Fed rate cuts has also not lifted US stocks much. This is wake-up call for investors. Here’s why this is happening and how it impacts your investment choices. 

MPC cuts, gilt yields rise

After hanging on to a repo rate of 6.5% until January 2025, the MPC flagged off a series of rate cuts, delivering a 100-basis point reduction by June 2025. It then went into a “dovish” pause, holding the rate but saying that it could cut further to support growth. This view was repeated in the latest MPC meeting.  

But the yield on the 364-day treasury bill, after tumbling from 6.5% to 5.5% between February and June 2025, has since swung back to 5.84%. The 10-year gilt has also behaved similarly. After falling from 6.8% in February to 6.1% in June, the yield has climbed back to 6.53% now. 

Three factors seem to be increasing gilt yields in the middle of a central bank rate-cutting cycle. 

#1 Near the floor

Bond markets know that, for all the dovish noises from MPC, this rate-cutting cycle is close to its end. If we look back at the past, repo rates in India have seldom dipped below 5% (the Covid low of 4% was a once in a blue moon event). There’s good reason for this. Interest rates in the economy need to yield a real return over inflation. CPI inflation in India has seldom stayed below 5-6% for any extended period of time.  Though inflation has been below 3% for a few months now, no one believes that this is a sustainable trend.

Therefore, the maximum extent to which the MPC can cut rates in the current cycle is another 50 basis points. If the repo rate rules at say 5.25%, the yield on 1-year bonds will need to trade at say 5.5-5.6%. The 10-year bond will need to factor in a higher term premium (extra return for taking duration risks) and trade at say, 6.25-6.5%. Current market yields are pretty close to this.   

#2 Global debt worries

For some time now, it has been clear that the world’s leading economies are flirting with a sovereign debt crisis. The US debt situation is a horror show (More on this in the BOX below). While the IMF has been putting out reports like the one in this link, governments don’t seem to be listening. But bond markets are. When lenders get worried about the ability of an entity to repay, they shy away from extending long-term loans. This has been happening with government bonds from the US, UK, France, Germany and other heavily indebted nations (watch this video for more). After recent sell-offs, yields on 10- to 30-year bonds in advanced economies are trading at decadal highs. It is this worry, partly, which has sent gold prices rocketing. 

Now, India is not in the same boat as these advanced economies on debt; it is much better placed. Its debt-to-GDP ratio is at a moderate 83% and the Indian government has been diligently shrinking its fiscal deficit. India recently earned a rating upgrade from the hard-to-please global credit rating agencies. But still, when differentials narrow between bond yields in emerging economies (EM) and those in ‘advanced’ ones, foreign investors sell EM bonds. Therefore, when bond yields rise in the US, UK or Europe rise, yields in India also rise in sympathy. The opening up of Indian bond markets to FPIs has increased such inter-linkages.  

# 3 Uncertainty on future cuts

MPC’s commentary in recent reviews suggests that it is open to further rate cuts, but there’s a good chance that they won’t materialize. For central banks to cut rates, they need clear signs that inflation is under control and that growth is in jeopardy. Today they have neither. In India’s case, a surplus South-West monsoon has moderated food prices, but with US trade negotiations still up in the air there’s little clarity on the tariff impact. If US tariffs stay in place in some form, they can be inflationary.

Earlier, there were expectations that Chinese dumping due to US tariffs would lead to deflation in industrial commodities. But China’s recent interventions to tackle its over-capacity problem dial back this possibility. Recent data (Q1 GDP growth of 7.8%) suggests that the Indian economy has been quite resilient so far to tariff uncertainty. With the government launching a blitzkrieg of tax reforms to stimulate consumption and MPC already cutting rates by a100 basis points, domestic growth doesn’t seem to be in great jeopardy. In the circumstances, MPC may decide not to cut rates further, to keep capital flows coming and shore up the weak Rupee. 

Why stocks didn’t rise 

Rate cuts by the MPC have not catalysed stock markets either, with the indices struggling to break out of a range. Why is this? While domestic investors remain bullish as ever, Foreign Portfolio Investors (FPIs) are not playing ball and have been consistently selling Indian equities. The reasons could be threefold. 

• One, when global markets look shaky and FPIs want to reduce risks, they usually sell emerging market stocks first. With the Nifty 50 trebling since Covid, India has been a top-performing market for the last five years. Therefore, FPIs have booked profits in India to lock into those gains. 
• Two, a weakening Rupee is probably spooking them about currency risks. 
• Three, Indian stock valuations are looking pricey as earnings growth is slowing sharply after post-Covid euphoria. The MSCI India Index is trading at a valuation of about 22-23 times while the EM index trades at 13-15 times. 

Falling interest rates would normally perk up growth. But thanks to elevated market yields, the benefits of policy rate cuts are not fully trickling down to earnings, consumption or capex intentions as of now. 

FPIs are likely to wait for signs of a sustained recovery in GDP growth (which can happen owing to tax and GST cuts) and for a revival in earnings growth, before raising their allocations to India once again. MPC actions in isolation may not do the trick. 

Takeaways

What does all this mean for your portfolio? 

• With central banks losing control over bond markets, yields seem to be at the mercy of demand and supply. To gauge how interest rates will move, demand-supply of gilts and the government’s fiscal situation is now more important than MPC actions. 

• The global bond scare is causing bond yields to turn more volatile. This makes bets on long duration (5 year plus gilts and bonds) riskier than before. Only investors with a 5-year plus horizon can own long duration bonds today. If you own long-dated bonds or funds which play on them but have a shorter horizon, you need to exit. Switch to high-quality bonds with shorter duration or funds which hold them. You can check Prime Funds for our recommendations.

• When you can’t trust government bonds from highly rated economies, where do you take shelter? Some investors think the answer lies in gold. This is why Morgan Stanley recently recommended a shift from a 60:40 portfolio to a 60:20:20 portfolio with 20% going to gold. However, with gold outperforming Nifty50 in the last five years and rising 55% this year alone, this is now a very crowded trade. If the debt fears prove to be overdone, gold can lose value rapidly, as it literally has no valuation metrics. We have always recommended that investors have a 10-15% allocation to gold to guard against Black Swan events. If you don’t have this allocation, you can acquire it through SIPs in gold ETFs. 

• But making wholesale switches from domestic bonds or gilts into gold doesn’t seem necessary for Indian investors today. Domestic bonds could correct in sympathy with any US turbulence, in the short run. But there’s nothing very wrong with the fundamentals of Indian gilts or its bond markets.