The bond yields had been range bound for a long time on the benchmark 10-year bonds in India. However, in the last one month, the bond yields have fallen nearly 40 bps from around 7.43% to a multi-year low of 7.03%. Let us look back at the key factors driving lower yields in India.
Low inflation expectations
Inflation, at the consumer level and the producer level, which had risen sharply in the last one year, has shown signs of tapering in the last couple of months. Despite a bounce in food prices that was supported by higher farm MSPs, the overall inflation has remained subdued. That is because fuel inflation and non-core inflation are down. Also with a global slowdown, the thinking is again veering towards low growth and lower inflation in the coming quarters.
US bond yields taper
The domestic bond yields have a link to the US benchmark yields because it is this spread that determines whether FIIs will invest in Indian bonds or not. The spread normally varies between 4% and 4.5% but of late the spread went up above the 5% mark. The US bond yields have fallen to a low of 2.12% on the back a dovish outlook by the Fed and lower growth expectations. This has also pushed the Indian bond yields lower and it has already lost over 120 basis points since September last year.
Expecting liquidity boost
The markets are already factoring in a major liquidity boost. The RBI is infusing nearly Rs.20,000 crore on a monthly basis through OMOs. On top of that, the RBI is also doing regular dollar swap auctions which also infuse liquidity into the system. With the kind of liquidity surge into bond markets, the yields are likely to be under pressure. Normally, liquidity pulls down yields at the shorter end and that gets transmitted to the longer end of the curve also.
Real rates need to fall
One thing that we often overlook is that Indian real rates are among the highest in the emerging markets. Indian bonds pay real returns of over 4% where the norm in other countries is between 1% and 2%. A fall in real rates was long called for and with the inflation consistently at lower levels there has been a real case to lower the interest rates. That is what is reflected in the yields on the benchmark bonds.
Global slowdown fears
With the trade war sustaining and the US yield curve inverting, there is fear of global recession that is engulfing the market. Normally, rates move lower when the growth expectations are downgraded. IMF has already lowered GDP expectations by 70 bps. That is really what yields are reflecting! ©