Indian government bonds extended their positive momentum this week, supported by robust demand for state debt and favorable liquidity conditions. Market sentiment was bolstered by a successful State Development Loan (SDL) auction where states raised 394.50 billion rupees ($4.35 billion). The auction saw cut-off yields fall below market expectations for the second consecutive week, reflecting strong appetite for sovereign and quasi-sovereign papers. This demand has helped stabilize the yield curve following a period of volatility in early 2026. The benchmark 10-year government bond yield is currently hovering around 6.67% to 6.68%. While yields briefly rose during Wednesday’s session, they remain near three-week lows. The 6.48% 2035 bond recently settled at a yield of 6.66%, marking a decline of approximately 11 basis points over the last six trading sessions. Liquidity remains a primary driver for the bond market's performance. The banking system is currently operating with a significant liquidity surplus, averaging 2.70 trillion rupees daily throughout February. This surplus, comfortably exceeding 1% of total bank deposits, has pushed overnight lending rates lower and encouraged banks to deploy funds into government securities. External factors are also providing a supportive tailwind. U.S. Treasury yields have trended downward, with the 10-year U.S. yield cooling to 4.03% following slower-than-expected retail inflation data. This narrowing of global yields has increased the relative attractiveness of Indian debt, particularly as foreign portfolio investors (FPIs) return to the market. After record selling in January, FPIs turned net buyers in early February, infusing over 8,100 crore rupees into the financial markets. This shift in capital flows is largely attributed to a stabilizing rupee—currently trading near 90.68 against the dollar—and the recent announcement of an Indo-US trade deal. The Reserve Bank of India’s proactive stance has further anchored the market. Through a series of debt-switch operations and open market purchases totaling nearly 4 trillion rupees between late 2025 and early 2026, the central bank has effectively managed redemption pressures and reduced the gross borrowing burden for the upcoming financial year. Despite the recent rally, some disconnect remains as the 10-year yield stays elevated relative to the repo rate, which was held steady at 5.25% in the February policy meeting. However, with headline inflation projected to remain muted at 2.1% for the 2025-26 fiscal year, the outlook for the bond market remains cautiously optimistic as investors eye further stabilization in borrowing costs.