What the global bond rout means for Indian equities and bonds

The US 30-year Treasury note breached the five percent mark.

Soaring bond yields across the globe might give way to a strong risk-off sentiment across global stock markets. However, despite the economic and financial turbulence, analysts and experts suggest that India’s debt and equity markets are better poised compared to peers.

Global bond yields have been climbing steadily, with the U.S. 30-year yield breaching the 5 percent mark and Japan’s 40-year yield hitting 3.5 percent.

The rise in yields comes amid 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.

In Japan, the government bonds are soaring against the backdrop of ballooning debt, and an aging population. The market is now demanding a higher risk premium to hold long-dated Japanese debt, exposing the fiscal vulnerability that policy had long masked, noted Arsh Mogre, Economist, PL Capital.

Investors of U.S. notes are asking for higher interest rates for the bonds with a longer maturity, such as the 20-year and 30-year notes, as they expect more volatility in the U.S economy over the long-term. The 30-year bond breaching the five percent mark indicates that investors are increasingly pricing in more risk to their capital in the long-term, therefore, demanding a higher return.

Morge explained that the 10-year note is still tethered to expected policy rates, while the 30/40-year yields reflect the part of yield that compensates for uncertain inflation, fiscal profligacy and buyer depth around two to three decades out.

The fiscal credibility is weak as well. The U.S debt-to-GDP ratio stands at around 122 percent, while in Japan, the ratio has ballooned to 255 percent. “The farther out the maturity, the more current investors demand compensation,” Mogre said.

The sole outlier to the bond market sell-off? India.

India enters this global repricing phase with inflation below four percent, bond yields stable at 6.2 percent, and $691 billion in FX reserves, providing one of the strongest buffers among EMs to absorb external volatility, added Mogre.

Impact on Indian bonds

During this time, Indian bonds 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.

Right now, the Indian yield curve is steepening, indicating that long-term interest rates are rising faster than short-term rates, and FPI activity is one of the factors driving this trend, noted Abhishek Bisen, Head – Fixed Income at Kotak Mahindra AMC. This means that investors are betting on strong economic growth going ahead.

Also, there is likely to be minimal impact from the global bond sell-off. In a conversation with Moneycontrol, VK Vijayakumar, Chief Investment Strategist, Geojit Investments explained that even though the 30-year and 40-year Japanese government bond yields are at 3.14 percent and 3.65 percent, the country’s 10-year is at 1.55 percent.

Therefore, the yield differential between India (which has a coupon rate of 6.25 on its 10-year government note) and Japan, is still large enough to attract investment in Indian bonds. Therefore, there is no immediate risk of selling in Indian bonds.

Joseph Thomas, Head of Research, Emkay Wealth Management added that country-specific investments into Japan or India do not change due to rise in yields. On the contrary, since yields are rising allocations to Yen bonds may be restrained as rates rise, bond prices fall and vice versa.

On the U.S.-front, while the yield spread between U.S. and India’s 10-year yields have compressed to 190 basis points. However, Mogre added that India’s growth premium and improving credit profile continue to position it as a structurally attractive EM allocation over the long term.

“However, we are not immune to any sharp global exogenous shocks to government bond yields,” cautioned Vishal Goenka, Co-Founder of IndiaBonds.com. “At these levels it’s important to watch global developments and risk-return tradeoff is skewed to the downside.”

Indian Equities

On the equities front, many experts pointed to a recent Bank of America survey that suggested India has recently overtaken Japan as the most preferred equity market in Asia among fund managers. This suggests that the overall appetite for Indian equities remains robust despite short-term outflows.

Abhishek Bisen added that there are no major outflows expected, given India’s strong macro story and ongoing global tariff concerns which may impact other markets more than India.

However, Devarsh Vakil, Head of Prime Research, HDFC Securities pointed to a key risk of Japanese yields rising on Indian equities: the yen carry trade (borrowing in low-yield JPY to invest in higher-yield assets elsewhere) will become less attractive. This may impact FPIs who borrow from Japan to invest in emerging markets, such as India. However, long-only and country-specific funds may not reduce flows to EMs.

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