Have India’s bonds decoupled from the global market?
If the performance of the domestic government bond yields and that of the benchmark US treasury notes are compared for the past two months, the answer may be a clear yes.
After all, the yield differential between the two markets is at its tightest in 13 years, with US yields having surged more than 150 basis points (bps), but local bonds being coy and showing an increase of just 25 bps. One basis point is one-hundredth of a percentage point. In fact, domestic government bond yields dropped briefly earlier this month.
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It is pertinent to note that much of the optimism in the domestic bond market has to do with the revival of hopes of India’s bonds getting included in global bond indices.
Various media reports have indicated that global bond index managers are looking to include Indian paper in all seriousness. That said, the government has not given any indication of meeting the conditions required for such inclusion.
While the inclusion debate is never ending, bond traders point out that the direction of yields in most markets is the same. Monetary policy is in a globally synchronised tightening mode with differences in the magnitude of tightening owing to economy-specific needs.
Indeed, the Reserve Bank of India (RBI) need not match the US Federal Reserve (the Fed) in the pace of rate hikes, but monetary policy has to be tightened by both central banks. Ergo, bond yields would rise irrespective of their jurisdiction.
“We cannot decouple from global markets in the long run. We can only decouple briefly,” said Jayesh Mehta, head of treasury at Bank of America. Mehta added that global volatility has hit the confidence of market participants when it comes to the outlook.
S.K. Mohanty, head of treasury at Bank of Baroda, agrees. "Globally what happens does affect us as domestic expectations change when global central banks announce steps. Hence, the decoupling argument is not sustainable beyond a point," he said.
This brings us to the Bank of England’s (BoE) volte face on Wednesday that befuddled the global market. The BoE announced that it would buy long-dated government bonds to cap yields, a move contradicting the central bank’s stance against inflation. UK gilt yields dropped by a huge margin which rubbed off on US treasury yields as well.
On Wednesday, US treasury yields dropped after their UK counterparts plummeted a massive 70 bps. The trigger was the BoE’s decision to buy long-term government bonds. The Indian 10-year benchmark government bond yield has climbed back up after a brief dip in early trade owing to the overnight drop in global bond yields.
If Thursday’s yield movement in domestic bonds is anything to go by, the decoupling theory which is offering comfort to equity investors isn’t cutting ice with fixed income.
“Right now, what the RBI will announce is important for the market. The expectation is of a 35-50 bps hike. I believe the probability of a 50 bps hike is high given the recent data and developments,” said Mohanty.
The RBI’s rate-setting committee is currently huddled in discussions to decide and vote on policy rates. A 50 bps hike in the repo rate is broadly priced into yields, but traders are more interested in what the RBI will say on Friday.
The rupee’s fall to fresh all-time lows has brought back uncomfortable questions on the potential external vulnerabilities as the country’s forex reserves slip. The impact of the RBI’s exchange rate policy on liquidity also cannot be ignored.
Mohanty believes that the central bank’s stance would determine the direction for bonds in the coming months. Mehta, of Bank of America, though, expects local bonds to follow global events, especially the measures of global central banks.
In short, domestic liquidity and interest rate outlook would be the driver for bonds, but global events will continue to have an overarching effect.