Narrower interest rate differentials between the US and Indian benchmark bonds might be here to stay, amid rising fiscal risks in the US, while monetary policy drives yields lower in India.
The US 10-year bond yields rose to the highest since February this year at 4.6%, with worries of a worsening fiscal outlook. This was even as India's benchmark bond yield continued to ease, at 6.2%, bringing the differential to 1.6%.
In case of the US, the rise in yields has been threatening to push up borrowing costs, while casting doubts on the US Treasuries' status as the world's safe haven.
In case of India, the easing yield on the benchmark G-Sec, is a reflection of the RBI Monetary Policy Committee's expected rate cuts, while it continues to infuse liquidity to ensure better transmission.
Over the mid term, the government has continued to perform better than expected in meeting its fiscal deficit targets, even amid India's inclusion in major global bond indices.
Under normal circumstances, the compression in interest rate differential reduces the attractiveness for holding rupee assets by foreign investors. However, that might not be a good predictor anymore, said Vivek Kumar, economist at QuantEco Research.
Interest rate differential is just one of the markers for assessing currency's relative attractiveness vis-a-vis the dollar, Kumar explained.
India's benign inflation outlook, relatively lesser likelihood of disruption to growth from global trade dislocations, and receding of rupee overvaluation concerns in last three-four months, puts it in a stable bucket for now, he added.
Madhavi Arora, lead economist at Emkay, who expects the India 10-year to ease to 6% by year-end, believes that changing global dynamics create the need to see select emerging market assets with fresh eyes, as their shock absorbing capacity improves, while US assets see a re-assessment. In contrast, the relative global calm offers a good opportunity to focus on domestic dynamics than to wait and act in more uncertain times, she added.
"Increasingly, the long end of the US yield curve is getting disconnected", Mahendra Jajoo, chief investment officer at Mirae Asset Investment Managers, said.
Participants have begun to feel that long end pricing is more driven by local factors and therefore RBI's accommodative policy will have more influence on Indian yields than what is happening in US, he said.
In a social media post on X, Uday Kotak asked if we will one day see Indian yields lower than the US.
India 10 year bond yield at 6.20% pa. US 4.60%. Gap of 1.60% is probably lowest I recollect. Will we 1 day see Indian yields lower than the US? Depends mainly on relative inflation, risk premium, trust, and liquidity, for global and domestic investors in these 2 countries!
While that might still be some time away, the case for narrowing differentials might be set to continue.
The impact of anticipated fiscal loosening in case of US and even Japan is reflective of the risk premium even in the mid-term. While, the scope of further easing remains in case of India, which is not yet close to full employment, like the advanced economies.
In the near term, sharp spikes in the US and Japan's longer dated securities can lead to some tightening in global financial conditions and create some volatility for India. We are, however, unlikely to see a spike in yields, given the expected dividend transfer and inflation trajectory, along with other factors, Emkay's Arora said.
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