India, US 10-year bond yield spread narrows to over 20-year low

Bonds

The spread between Indian bonds and US bonds maturing in 10-year fell to its lowest in over 20 years to 164 basis points (Bps) after the yield on the latter rose sharply over the fiscal deficit concerns.

According to the Bloomberg data, spread is lowest since July 28, 2004, when it was at 135 bps. Today, Indian 10-year benchmark bond yield was trading at 6.2496 percent, and 10-year US treasury yield at 4.5866 percent.

The rise in yields on US treasury comes after the progress of Trump’s spending and tax bill in Congress, which is expected to widen the country’s federal deficit. The soaring U.S. bond yield was a result of poor response to the $16 billion auction of 20-year U.S. Treasury Bills, which were sold at a higher coupon rate than previously anticipated.

Further, despite calls to cut rates, the U.S. Federal Reserve has held firm, which increases the cost of servicing U.S.’s national debt. This has led investors to dump bonds, pushing yields even higher in turn.

On the other hand, Indian bond yields have been ticking downwards steadily, as a result of its strong macroeconomic and fiscal position. Further, investors are betting on an interest rate cut from the Reserve Bank of India in June, therefore locking in higher yields before the impending monetary policy easing.

Money market experts said that a narrowing of the spread between both countries can lead to foreign investors pulling out money from Indian markets.

Usually, when the spread between two government bonds—or the gap between the yields in the bonds issued by the two countries—narrows, foreign investors pull back their funds from emerging economies and park it in home countries. This is because when the differential is lower, foreign investors end up earning lower returns as it gets adjusted with the currency exchange rate and other expenses related to compliance.

On May 15, Moneycontrol reported that even as the Securities and Exchange Board of India (SEBI) proposed easing regulatory compliances for foreign portfolio investors (FPIs) in a note on May 14, the narrowing of the spread between Indian and US bond yields could limit investment by these entities in domestic bonds in the short run.

FPIs investment in Indian bonds under the fully accessible route (FAR) has moved in a narrow band since the start of rate RBI’s cut cycle because these entities moved funds at a very slow pace due to the narrowing yield.