Impact of high US Treasury yields on India

Impact of high US Treasury yields on India

Subject :Economy

Section: External sector

Context: US treasury yields have touched 5%.

• Recent Trends in US Treasury Yields and Global Markets:
  • US 10Yr Treasury yield was rangebound between 3.25% and 4.1% from January to April before gradually rising.
  • A sharp increase in the yield to 5% in October resulted in a strong selloff in global equities.
  • Gold prices rose in October due to increased risk aversion after the Hamas-Israel conflict.
  • The recent fall in the US 10Yr yield post-Federal Reserve meeting provided relief for stock indices.
• Interest Rates and Peak Forecasts:
  • The US Federal Reserve’s projection indicates a peak fund rate of 5.6% for 2023, with a potential rate cut in 2024.
  • Historical data suggests that previous interest rate peaks were followed by recessions, indicating a possible recession in the US by 2024.
• US 10Year Yield Forecast:
  • Anticipated range for the US 10Yr Treasury yield is 4.5% to 5% in the near term, with a possible peak around 5.3-5.5%.
  • Forecast suggests a potential decline to 4.8-4.6% or 4.5% as the interest rate starts to decrease.
• Impact on Other Asset Classes:
  • The US dollar index is expected to rise to 108-110 before falling back to 105-103.
  • Equities may face prolonged pressure, with potential falls for the Dow Jones and Nasdaq Composite indices, as well as India’s Nifty.
  • Gold is anticipated to reach $2,100-$2,150 in the coming months.
  • Brent Crude oil may rise to $100-$105, supported by production cuts and supply disruption worries.
• Indian Yield Trends:
  • India Government Bond (IGB) 10Yr yield is expected to rise to 7.5-7.6% and then fall back to 7.3-7.2% in the first half of the next year.

Highlights the recent trends in the US Treasury yields and their potential impact on various asset classes, as well as forecasts for the future movements of these assets.

Bond:

• A bond is a form of debt investment issued by corporates or governments directly to investors for financing various projects and activities.
• It serves as a means to raise funds outside of traditional bank loans.

Bond Yield:

• A bond yield represents the return an investor gains from a bond.
• Investors lend money to bond issuers, who promise to pay interest and repay the bond’s face value.
• Yield includes earnings from holding and selling bonds.
• Bond prices and yields have an inverse relationship.

Factors Influencing Variation in Bond Yields:

• Economic conditions affect bond yields, with safer investments preferred during economic instability.
• Increasing interest rates generally lead to lower bond prices and vice versa.
• Lower-rated bonds offer higher yields due to the increased risk of default.
• Perceived risk of inflation influences bond yields.

Impact on the Economy:

• Banks face losses on treasury operations due to rising bond yields.
• Money market stability is affected by surging yields.
• Top-rated public-sector companies delay tapping into the debt market.
• Bond market weakness persists until stabilization of oil prices or global yields.
• Higher bond yields raise production costs, impacting earnings.

Impact on Bond Investors:

• A rise in bond yield indicates an anticipation of increased interest rates, leading investors to sell their existing bond holdings to limit capital losses.
• Debt funds’ net asset values, comprising government securities, may decline due to falling bond prices caused by rising yields.
• Corporate bonds, priced higher than government bonds, are also affected by the decline in bond prices.
• Debt investors suffer as higher yields cause a decline in bond prices and net asset values of debt funds.
• Rising bond yields negatively impact equity investors as they lead to increased costs for companies, potentially affecting their earnings.

Bond Yields vs. Equity:

• Bond yields and equities have an inverse relationship, with a rise in bond yields suggesting a need for an increased risk premium on equities.

Relationship between Bond Price and Yield:

• Bonds and their yields have an inverse relationship, with higher bond prices leading to lower yields.
• Fixed-rate nature of bonds results in investors selling bonds when they expect interest rates to rise and vice versa.
• Conversely, bond investors might purchase bonds if they anticipate future interest rate reductions, thereby driving prices higher.

RBI’s Control of Bond Yields:

• The RBI endeavors to keep yields lower to reduce government borrowing costs and prevent upward movements in market lending rates.
• It achieves this by repurchasing government bonds or conducting open market operations to temper yields.

The potential impact of a rate hike in the US on other markets, including India, can be summarized as follows:

1. Currency Carry Trade Impact:
   • The narrowing gap between interest rates in the US and countries like India could make India less attractive for currency carry trade.
   • This shift may result in capital outflows from India, affecting its currency value and overall market stability.
2. Global Growth Concerns:
   • A higher rate signal by the US Federal Reserve may indicate a reduced impetus to growth in the US, which could have negative implications for global economic growth.
   • Slower growth in the US might indirectly impact the demand for goods and services globally, including in India.
3. Equity Market Concerns:
   • Higher returns in the US debt markets could lead to a reevaluation of investments by foreign investors, potentially impacting emerging market equities, including those in India.
   • This could lead to a reduction in foreign investor enthusiasm and create volatility in Indian equity markets.
4. Currency Market Volatility:
   • The potential outflows of funds due to the shift in investor sentiment and changes in interest rate differentials may result in increased volatility in currency markets, impacting the value of the Indian rupee and other emerging market currencies.

Yield Curve Inversion:

• A yield curve represents the interest rates on bonds of increasing maturities.
• An inverted yield curve occurs when short-term debt instruments offer higher yields than long-term instruments of the same credit risk profile.
• Inverted yield curves are atypical and can signal an impending recession, with implications for consumers and investors.

Reverse Currency War:

• As a response to the US Federal Reserve’s aggressive interest rate hikes, more investors are rushing to invest money in the US, strengthening the dollar against other currencies.
• Central banks are working to counter the US Fed by raising their own interest rates to prevent excessive devaluation of their currencies against the dollar.
• However, raising interest rates carries its own risks, potentially hampering the chances of achieving a soft landing for any economy.

Soft Landing:

• A soft landing refers to a cyclical slowdown in economic growth that avoids a recession.
• Central banks aim for a soft landing by raising interest rates to curb an overheating economy without causing a severe downturn.
• It can also indicate a gradual slowdown in a particular industry or economic sector, with a focus on minimizing negative impacts.