Fixed-income investors are urged to exercise caution in 2H2026E and favour short- to medium-term yields, as short tenors are expected to adjust downwards and converge with First Capital Research's projected targets, according to the firm's Mid-Year Outlook for 2026.

"Looking ahead, with medium- and long-term tenors already trading within our target bands, we believe there is further scope for short-term yields to decline and converge towards our projected ranges during 2H2026E, before remaining broadly stable throughout 1H2027E."

This outlook follows the Public Debt Management Office's yield correction efforts, which have corrected the market overreaction seen after May's rate hike, bringing medium and long-term yields back in line with forecasts, the research unit noted.

"The 100bps policy rate hike implemented by CBSL in May 2026 pushed the yield curve well above our guidance, reflecting what we viewed as an overreaction by investors."

The PDMO's correction efforts, according to the unit, included reduced acceptance of the Weighted Average Yield Rate and rejection of longer-tenor bids since the hike. "However, subsequent direction from the PDMO, through reduced acceptance of the WAYR and the rejection of longer-tenor bids at recent auctions, helped correct this overreaction, bringing yields back in line with our projected levels."

Staying within a cautious framework, the unit warned that amid the volatile global situation brought on by the ongoing Middle East conflict, Sri Lanka's below-target reserve buffer, which can only cover approximately 3.5 months of imports, has exposed the nation to external vulnerabilities.

In June, Sri Lanka’s gross official reserves declined from $ 6.8 billion, to $ 6.4 billion. At the recent Monetary Policy announcement, the Central Bank Governor confirmed that the outflows were due to Sri Lanka’s increased expenditure on imports, due to global elevated petroleum prices, and demand for vehicle imports.

The International Monetary Fund expects Sri Lanka to maintain a year-end target of $ 8.9 billion in gross official reserves, as part of its fiscal discipline programme. First Capital however has projected that Sri Lanka is likely to miss this target by roughly around 19%.

Emphasising the advice for investors to remain cautious and opt for short and medium-term bonds, the unit added that the longer end of the curve is likely to face mounting selling pressure as markets begin pricing in Sri Lanka's external debt obligations from 2028 onward.

"As a result, we expect investors to maintain a cautious stance, favoring short- to medium-term tenors, while modest selling pressure is likely to persist at the longer end of the curve in anticipation of rising external debt repayments from 2028E onwards. Accordingly, we continue to incorporate a 50bps premium on longer-term tenors in our 1H2027E projections.