Domestic bond markets have rallied sharply on account of rate softening by RBI as well as a rate cut by the US Fed. India’s sovereign bond yield recently dipped to a 10-year low.
Is there trouble for investors ahead? Should you take your flight to safety? These graphical analyses will give you a clearer picture of the scenario.
The Reserve Bank of India has cut policy rates to the lowest since 2010 Domestic interest rates have been cut by 110 basis points to a nine-year low of 5.4%. The central bank has embarked on a rate softening regime to boost slowing economic growth.
The US Federal Reserve has also cut rates after a long time The US Fed cut rates taking into account muted inflation and global developments that threaten to hurt growth prospects. It has left doors open for more rate cuts in the future. This has boosted sentiment and fuelled bond market rallies worldwide.
India’s sovereign bond yield recently dipped to a 10-year low Bond prices and yields move in opposite directions. India’s benchmark government bond yield has dropped to its lowest since the subprime crisis of 2008.
Domestic bond markets have rallied sharply on account of rate softening by RBI as well as a rate cut by the US Fed.
Trimming of fiscal deficit target by the government and planned shift in part of government’s borrowing to overseas markets (leading to lesser domestic supply of government bonds) has also led to euphoria in the bond market.
Widening of bond yield spreads signals flight to safety The gap in yield between highest grade corporate bonds over comparable government securities has increased. As credit events singed bonds of even the highest grade companies, investors flocked to the safety of government debt. This also means that borrowing costs of corporates have not come down in proportion to drop in interest rates.
The gap between bond and equity earnings yield is narrowing The lower yield from the Nifty index relative to government bond yield typically means the stock market is expensive. However, narrowing of this gap indicates that risk-reward situation has improved in favour of equities. The bond-equity earnings yield gap indicates how the risk-reward ratio is tilting in terms of macro asset allocation. Earnings yield is the inverse of price-earnings ratio and calculated by dividing earnings per share by the market price of the stock.
Central banks worldwide are on the rate cut path As economic slowdown grips nations globally as a fallout of trade wars and protectionism, central banks have had to ease interest rates in an attempt to revive growth.
Investor concerns about slowing global growth and easing of monetary policy in the world’s largest central banks have sent bond yields tumbling in many countries. A negative interest rate means you have to pay to keep your money in the bank. Investors in such bonds are not receiving interest but must pay more than the face value of the bonds to acquire them. This is a deliberate policy designed to spur economic growth by forcing people to spend and invest rather than keep money idle. It also incentivises banks to lend more aggressively. However, this is a new phenomenon and no evidence exists supporting its utility.
Inverted or near-inverted yield curves in global bond markets spell trouble ^as on 14 Aug | # as on 16 Aug
When longer tenure bonds yield lower than shorter tenure bonds, it results in inversion of the yield curve.
Inverted yield curve is considered a leading indicator of impending recession. In the US, since 1967, every major recession has been preceeded by inverting of the yield curve. Typically, investors demand higher yields from longer-term bonds to compensate for the higher risk of keeping their money tied up for a longer period. But when yields on shorter term bonds rise above longer term bonds, it signals that the bond market is expecting trouble ahead.
Source: Bloomberg | Compiled by ETIG Database | Data as on 12 August
