The 10-year Bond yield shot up to 7.42%, the highest in the past three years after the Reserve Bank of India announced a 40 basis point interest rate hike in an off-cycle meet of the monetary policy Committe (MPC).

The yields on the 3-year and 5-year bonds went up by 39 bps and 31 bps, respectively.

The RBI increased the Repo rate to 4.40% and hiked the Cash Reserve Ratio (CRR) by 50 basis points to 4.5% from May 21.

The Repo rate is the rate at which banks borrow money from the central bank, while the CRR is the certain minimum amount that commercial banks have to keep as deposit with the central bank.

"The MPC noted that domestic economic activity is progressing broadly on the lines anticipated in April," Governor Shaktikanta Das said in an online address.

"At the same time, the MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that the second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored," he added.

The sudden hawkish move by the central bank of India jostled the financial markets and experts expect yields could go up further as the central bank is seen to hike interest rates again in the scheduled policy review meeting in June.

But what does this mean for the Bond market?

Interest Rates have an inverse relationship with Bonds pricing. At the time of purchase, the investor gives the money in lieu of coupon payments at a fixed rate of interest. However if the market rate rises from the time of the purchase of the bond, it effectively means the investor has invested in a bond which now pays a lesser interest rate differential than it used to at the time of purchase. Because of this, the demand for the bond will go down as investors would prefer investing in securities providing better returns, hence the price of the bond will fall. The bond will then trade at a discount to reflect the lower return that an investor will make on the bond.

But rising interest rates should not deter investors from the bond market. Here is how, you can counter the effects of rising rates.

Short-Term Bond Strategy

When interest rates are rising, bond investors should reduce the duration of their bond portfolios. A bond's duration measures how sensitive it is to interest rate changes. If the interest rate on a bond with a duration of 10 rises by 1%, its value will likely drop by approximately 10%.

Floating-rate Bonds

A floating rate savings bond (taxable) is a debt instrument issued by the government of India. Floating-rate bonds are a good purchase in an environment of interest rate hikes because of their inherent nature to adjust to rising interest rates and coupons that accrue to investors keep rising as the benchmark or overall RBI rates move higher. Also, floating-rate bonds have a positive correlation with rising interest rates and, therefore, returns on floating rate bonds are positively aligned to rising rate scenarios.

Going ahead, bond market participants expect the RBI to raise the repo rate to the pre-pandemic level of 5.15 percent in the next few meetings. Therefore, it is prudent to apply these strategies in your bond investment decisions for better returns.