Rising yields on government securities or bonds in the United States and India have triggered concern over the negative impact on other asset classes, especially stock markets, and even gold. The yield on 10-year bonds in India moved up from the recent low of 5.76% to 6.20% in line with the rise in US yields, sending jitters through the stock market, where the benchmark Sensex fell 2,300 points last week.
With over Rs 70.55 lakh crore of government securities (G-Secs) outstanding and the government planning to borrow more from the market through G-Secs, the movement of yields will continue to be watched in the coming months.
Why do bond yields rise?
Bond yield is the return an investor gets on that bond or on a particular government security. The major factors affecting the yield is the monetary policy of the Reserve Bank of India, especially the course of interest rates, the fiscal position of the government and its borrowing programme, global markets, economy, and inflation. With the pandemic upsetting the calculations, Finance Minister Nirmala Sitharaman has pegged the fiscal deficit for 2021-22 at 6.8% of GDP (the original target was 3.5%), and aims to bring it back under 4.5% by 2025-26.
A fall in interest rates makes bond prices rise, and bond yields fall — and rising interest rates cause bond prices to fall, and bond yields to rise. In short, a rise in bond yields means interest rates in the monetary system have fallen, and the returns for investors (those who invested in bonds and govt securities) have declined.
How has the rise in yield affected stock markets?
The sudden rise in domestic and global bond yields recently moderated the enthusiasm of equity market participants around the world. The “taper tantrum” of 2013 showed the relationship between bond yields and stock markets — a sudden rise in bond yields caused markets to slide, as mass bond selling was witnessed. “Bond yields are inversely proportional to equity returns; when bond yields decline, equity markets tend to outperform, and when yields rise, equity market returns tend to falter. This could be one of the reasons for the Nifty’s correction this week,” said Nirali Shah, Head of Equity Research, Samco Securities. Traditionally, when bond yields go up, investors start reallocating investments away from equities and into bonds, as they are much safer. As bond yields rise, the opportunity cost of investing in equities goes up, and equities become less attractive.
Also, a rise in bond yields raises the cost of capital for companies, which in turn compresses the valuations of their stocks. That is something that investors see when RBI cuts or raises the repo rate. A cut in the repo rate reduces the cost of borrowing for companies, leading to a rise in share prices, and vice versa.
How will the borrowing programme and economy be impacted?
When bond yields rise, the RBI has to offer higher cut-off price/yield to investors during auctions. This means borrowing costs will increase at a time when the government plans to raise Rs 12 lakh crore from the market. However, RBI is expected to stabilise yields through open market operations and operation twists. Besides, as government borrowing costs are used as the benchmark for pricing loans to businesses and consumers, any increase in yields will be transmitted to the real economy.
Will high yields impact the flow of foreign portfolio investment (FPI) funds?
Yes. Bond yields play a big role in FPI flow. Traditionally, when bond yields rise in the US, FPIs move out of Indian equities. Also, it has been seen that when the bond yield in India goes up, it results in capital outflows from equities and into debt.
A higher return on treasury bonds in the US leads investors to move their asset allocation from more risky emerging market equities or debt to the US Treasury, which is the safest investment instrument. So, a continued rise in yields in developed markets may put more pressure on Indian equity markets, which may witness an outflow of funds. Even a rise in domestic bond yields would see allocation moving from equity to debt.
How have bond yields moved in the recent past?
During the first half of 2020-21, bond yields were mostly below 6% due to effective yield management by the RBI. “However, this changed after the Budget when the government upped its borrowing programme for the current fiscal, and has announced an aggressive one for FY22. With just over a month left in FY21, the market is still expecting a consolidated borrowing amount of more than Rs 2.5 lakh crore as per the auction calendar of the Centre and states,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.
India’s 10-year benchmark bond touched 6.20% last week. The average increase in government securities yields across 3, 5, and 10 years has been around 31 basis points since the Budget. Corporate bonds rated ‘AAA’ and SDL spreads have jumped by 25-41 basis points during this period.
Are rising yields a global phenomenon?
Yields have already risen across the world, and they are almost certain to rise further in the US, especially if the Biden administration gets its $1.9 trillion package over the line. A slow but steady rise will allow other asset classes to adjust. A rapid increase in the US yields will likely spark nerves in the buy-everything aficionados. Bond yield in the US, which was at 0.31% in March 2020, touched 1.40% recently. In the UK, 10-year bonds rose 40 basis points in February to touch 0.76% this week. While Federal Reserve Chairman Jerome
Powell this week termed the recent run-up in bond yields “a statement of confidence” in the economic outlook, European Central Bank President Christine Lagarde said they are “closely monitoring” government debt yields.
What should investors keep in mind?
Bond yields move on account of various factors, and investors will have to keep an eye on both domestic and global developments while investing in them. If inflation and interest rates in the economy are key factors that determine yields, they are in turn affected by various other factors such as economic growth, sovereign rating, money supply, government borrowing, global liquidity and geopolitical developments. With the RBI now allowing retail participation in G-Secs, investors need to be watchful of developments before taking a decision.