Dear Reader,
The 10-year US treasury note, which decides the borrowing cost of every borrower in the world including its own government, is running at a yield of 4.6 percent, an uncomfortable level seen after a long time. Across the pond, the UK gilt market, and even German bunds are squeezing their respective governments. It is a matter of time that bond yields of emerging market economies begin to rise earnestly if they have not already started to do so. If yields rise, prices of bonds fall resulting in losses for investors.
Yields are now climbing across geographies, irrespective of where their respective central banks are in the easing monetary policy spectrum. Indonesia’s central bank slashed policy rates on January 15 and yet its bond yields remain elevated. India’s sovereign bonds are perhaps in the sweetest spot in terms of policy as fiscal discipline is likely to continue while the Reserve Bank of India could cut policy rates next month. Yet, the 10-year benchmark bond yield has climbed over the past month.
If we rewind just a little over three months, the narrative in the bond markets across geographies was markedly different. Central banks were gearing up for chopping policy rates after consumer prices finally began to cool off. The bond market was on its way to set investors for a handsome reward in 2025. What has happened in three months?
Much of the finger pointing is towards inflation. In advanced economies such as the US and the UK, concerns about inflation are rising again and in emerging market economies the fall in inflation is far slower than expected. Simply put, consumer prices are not behaving like they did a month back. More importantly, inflation is expected to rise. But that is not the full story.
Mr Bond can anticipate inflation as the bond market has shown the mirror to every other market in the past when inflation cues have been misread. In fact, bond markets are supposed to keep policymakers and government honest in their assessment of prices. What Mr Bond doesn’t like is being played by uncertainty. That is when investors charge a steep term premium for holding long-term bonds. As an article titled ‘Why global bond markets are convulsing’ from The Economist (part of our Reading List for you) states, “..increases in the premium on 10-year treasury yields account for nearly all the rise in these yields since early December.”
That is when US President-elect Donald Trump began to lay out his possible policies once he takes office. Trump has blown up an already uncertain world into a complete high stakes game where nobody can measure any outcome’s probability.
Perhaps, the best capture of the current uncertainty is within bond markets. As US treasury yields rise, bond yields in China have been falling consistently over the past two years. This divergence in the two largest economies, overlayed by the political cold-shouldering and a brewing trade war, is enough to keep investors guessing rather wildly about outcomes. Will China’s slump be able to offset Trump’s tariff-infused inflation? The latest gross domestic product (GDP) reading of China defies this proposition. Will Beijing devalue its currency in the wake of tariffs, unleashing perhaps a deflationary force into markets? We have no clue.
With all these questions, bonds that guarantee a fixed return, must compensate, and perhaps even overcompensate for uncertainty. That is a key reason for the relentless climb in yields today. There is more to the story.
Both America and the UK are cradling an unprecedented level of government debt. When you promise the bond market of a load of supply that it may not be able to absorb, the logical outcome is a surge in yields. Here emerging economies are better placed, though not all of them are shipshape. Mr Bond will exact vengeance for lackadaisical fiscal indulgences, if not immediately then definitely later. Perhaps that comeuppance has arrived.
What should investors do when vigilantes have awoken in the bond market? For India’s equity investors, there is no respite yet. Ananya Roy in her latest column warns of event-heavy weeks ahead with the Union Budget and the RBI policy due in February. The central government needs to meet the demands of the economy, boost consumption as our Budget Snapshot states owing to the fall in household savings, give startups support as this column proposes and at the same time reduce the fiscal deficit to 4.5 percent of GDP. That would give the RBI some legroom to consider cutting policy rates.
But would Mr Bond take note of such salutary events? We will know in February.
Investing insights from our research team
RIL Q3 FY25: Consumer businesses drive performance, support outlook
Infosys Q3 – Soft implied guidance for Q4 dampens an otherwise strong quarter
Axis Bank Q3 FY25 — Better to be on the back foot in the near term
Weekly Tactical Pick: This high-quality capital goods player offers an interesting opportunity
LTI Mindtree Q3 FY25 – Ready for the long term despite near-term challenges
CEAT Q3 FY25: Bumpy ride, but valuation offers comfort
What else are we reading?
Infosys vs Ravi Kumar signals the end of amicable exits in Indian IT
How can India get rich before it gets old? What does a shift from minimum wage to living wage mean for India’s poor?
Donald Trump’s Treasury pick says unwinding tax cuts would spark ‘economic calamity’ (republished from the FT)
Key Expectations for Union Budget 2025: Tax reforms and relief
IBC: Striking a balance between corporate revival and challenges
Mohan Bhagwat's remarks on Ram Temple and India's independence explained in historical context
The inflation genie is moving to the White House
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Orios Venture Partners delays closure of third fund for a third time
Technical Picks: ICICIGI, BDL, KOTAKBANK, BDL.
Aparna Iyer
Moneycontrol Pro
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