Rising yields of benchmark government securities across global markets has remained the most discussed subject in recent weeks, triggering concerns not only in bond markets alone but other asset classes as well. The yield of US 10Y treasury has reached a high of 1.6% in March from low of 0.50% last year and an average of 0.8% during 2020, India 10Y benchmark also reached high of 6.25% after trading around 5.75% in early part of 2021.
The surge in yields has also led to slightly negative sentiments in equity markets and correction in gold prices. Nasdaq has seen a fall of ~8% from its peak, gold has dipped ~17% from its peak in 2020. Oil prices are also near a two year high at around $ 70 pb due to OPEC keeping supplies under check. In fact, many of the major commodities like copper/Iron ore/Steel have seen an uptick of 50-100% in their prices in last 1 year.
But why is all this happening, why is there surge in bond yields and how is affecting other asset classes is one of the most discussed topics in the market presently. Let us try to first understand why commodity prices are rising, it is not only because of high demand, it is also supply-side concern. E.g., Brazil has cut down its iron ore production by about 26% which is a perfect storm for price rise when there is good demand due to reviving global economy and supply has been cut back. Similar is the case with copper, aluminium and nickel. All these markets have supply side bottlenecks hence the prices continue to rise.
The primary underlying concern behind this rise in yields seems a strong belief in a strong return of inflation in developed world. While the rising commodity prices will contribute to a spike in inflation, market seems to suggest that the huge fiscal expansion during covid period by major economies, ranging from 10-20% of GDP may lead to a comeback for inflation. In US, optimism on economic revival supported by roll out of vaccine and strong fiscal stimulus (fresh round of US $ 1.9tn), a muted response from Fed on rising yields and somewhat of endorsement of market assessment of an inflation comeback and unwillingness to commit to extend the maturities of securities being bought under ongoing Q/E has disappointed bond traders.
Even though other major central banks like ECB and BOJ has repeatedly showed concern on rising yields, no definitive action is yet seen, apart from Reserve Bank of Australia which announced an additional buying of A$ 100 bn of government bonds. This lack of affirmative action over current situation has left the traders in a blind spot keeping the pressure on yields.
Domestic markets are naturally affected by the global developments. In tandem with global developments, higher fiscal deficit and consequent larger than expected borrowing target has caused the 10Y govt bond yields in India also to surge ~25bps to 6.25% now, a nearly one year high. Concerns are building up over government borrowings crowding out private sector credit demand as economy picks up pace in coming quarters.
However, unlike other major central banks, RBI has been quite vocal about need to keep interest rates under check to continue supporting growth revival and has undertaken massive open market operation (OMOs) that has kept yields under check. In an OMO announced last week, RBI announced purchase of securities worth Rs 20k crs against which it will sell securities worth Rs 15k crs. In addition, the securities that are to be purchased by RBI are the ones which were recently auctioned which Indicate the strongest intent yet by RBI towards keeping rates low. However, market appetite has suffered and last few auctions have seen rejection or devolvement on primary dealers.
While the central bank is expected to remain supportive, the benchmark yields which were expected to remain range bound in the first half of the year has already surged quite a bit. The good news for India is that macro-economic situation is fairly stable. While covid situation remains largely stable, vaccine drive is already rolled out (considering we have previous vaccine drives in place, it should be relatively faster inoculation of the nation). Inflation has already fallen to 4.09% in February and is expected to remain range bound in near term.
Economic recovery is still in nascent stage and therefore it’s important that RBI continues to support the recovery process. Monsoon will play a key role in shaping policy response going forward. It would seem that momentum in rising yields globally is slowing down now. With RBI strongly standing firm to keep yields reacting in an orderly manner, rates are expected to stabilize and remain range bound in near term after the recent spike.
Investors with long term horizon should stay invested and have patience with intermediate volatility. While there is likely going to be some dip in returns during the period when yields are rising, this is also the time when fresh flows and maturities can be invested at higher rates. Thus, those willing to sit through a complete rate cycle will possibly have a much better investment experience.
(The writer is the CIO, Fixed Income, Mirae Asset Investment Managers (India) Pvt. Ltd.)