The Indian bond market succumbed to selling pressure after the RBI Governor announced open market operations(OMO) to sell the bonds during his policy statement on 6th Oct 2023. India’s 10-year bond yield saw the biggest rise of 14 basis points(around 2%) in the last 14 months post the Governor’s statement. Borrowing of around Rs 3.5 lakh crores by the GoI in the remaining fiscal year coupled with the surprise announcement by the RBI for OMO saw the bond prices fall like a nine-pin. India’s 10-year bond yield is currently trading around 7.35%.
Does this current high bond yield environment present a promising investment opportunity, particularly in the context of India? In this article, we’ll delve into various factors that shed light on this question. For ease of understanding, there is an inverse correlation between bond yields and bond prices. An increase in bond yields implies low bond prices.
Global Bond Yield Landscape. The US 10-year bond yield has witnessed a remarkable surge, as the US Federal Reserve hiked benchmark interest rates from nearly 0% in 2020 to the current rate of 5.5%. Consequently, the US 10-year bond yield now stands at 4.8%, its highest point in seventeen years. This rapid rise has had a significant impact on several aspects of the US economy to say a few:
- Housing Market Challenges. The US 30-year mortgage rate has risen to over 7.5%, the highest since 2000, compared to roughly 3% in 2021. The resulting increase in borrowing costs has placed substantial strain on homebuyers, causing their monthly mortgage payments to soar.
- Mounting US Debt. With the USA carrying a staggering debt burden of approximately $32.83 trillion, the interest bill on US Government debt reached around $800 billion in the past eleven months, marking an increase of about $130 billion from the previous year. Further interest rate increases could exacerbate this liability.
- Moody’s downgrade of US banks. The collapse of Silicon Valley Bank in Mar 2023 and Moody’s recent downgrade of 10 US banks by one notch and the placement of some major banking institutions under review for potential downgrades have sent shockwaves through the US banking system.
- Global Debt Crisis. According to the Institute of International Finances, the first half of 2023 saw a record global debt of $307 trillion. The ability of debt-burdened nations to handle further interest rate hikes is increasingly tenuous.
Until recently, individuals, businesses, and governments in the USA, Europe, and parts of Asia enjoyed a period of historically low-interest rates. However, the rapid increase in interest rates by the US Federal Reserve and European countries over the past eighteen months has generated significant economic distress worldwide. Although a further interest rate hike may not be an immediate option, the current rates could persist longer than anticipated.
In contrast, the Reserve Bank of India (RBI) has been more measured in its approach to interest rate increases. The last 25-basis-point rate hike occurred in February 2023, with the repo rate at 6.5%. Despite the US Fed’s actions, the Indian currency and the 10-year bond yield have remained resilient, thanks to the inherent strength of the Indian economy and robust dollar reserves.
- While the US Federal Reserve appears inclined to maintain higher rates for an extended period, this approach could inflict considerable stress on the banking system, housing market, and government interest payments in the US and Europe, while also impacting other asset classes negatively.
- The Indian economy, in contrast, stands out as the world’s fastest-growing economy, projected to grow at 6.5% in the current fiscal year according to the recent RBI monetary policy statement.
- The recent spike in the Indian 10-year bond yield, triggered by the unexpected OMO announcement, is expected to subside in the coming days. Furthermore, the interest rate cycle in India appears to be approaching its peak, as does the bond yield. With the inclusion of the Indian bond market in the JP Morgan Govt Bond index-Emerging Markets from June 2024, significant investments in dollars are anticipated, likely driving down bond yields further. This presents a favorable outlook for bond investments.
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Data source- Bloomberg.