Impact of RBI's 40 basis points rate hike on debt fund investors!

The RBI surprised the market yesterday by raising key policy rates by 40 basis points. What effect would this have on debt fund investors? Let us investigate.

The Reserve Bank of India (RBI) stunned the market yesterday by raising its key policy rates by 40 basis points (100 basis points equals one per cent). Market participants were expecting a rate rise at the next Monetary Policy Meeting in June 2022, although this was heavily discounted.

The RBI, on the other hand, unexpectedly raised interest rates yesterday, which was not discounted. As a result of the earlier-than-expected rise in policy rates, markets (Nifty 50) fell 391 points, or 2.29 per cent, to 16,677.60.

Since 2018, markets have had a first-rate increase. The RBI governor, however, stated that the accommodative approach will be maintained. The RBI also increased the Cash Reserve Ratio (CRR) by 50 basis points to 4.5 per cent effective from May 2022. Bond yields soared from 3.64 per cent to 7.38 per cent, which was about 7.6 per cent, due to a huge sell-off in the bond markets.

Impact on Debt Fund investors

Bond prices, as you may know, are inversely related to interest rates. As interest rates decrease, bond yields rise, the Net Asset Value (NAV) of debt funds rises, and vice versa. As a result, yesterday's rate hike, as well as others that are on the way, will cause bond yields to rise, which will hurt debt mutual fund investors, particularly those that invest at the higher end of the yield curve.

It is recommended to invest in floater funds, short-duration funds, and ultra-short duration funds in the current market environment. Furthermore, if you are saving for any of your financial goals, target-date debt mutual funds are a wonderful option.