Last year in May, Jayesh Mehta predicted the Reserve Bank of India would lower interest rates, when practically everyone was expecting a hike. The RBI delivered a cut in August. Now, the 30-year bond veteran is back with another bold call: the selloff in Indian sovereign debt that saw yields surge around 135 basis points since August may soon be at an end.
Mehta, the country treasurer for India at Bank of America Merrill Lynch, is contemplating a return to the market, five months after he stopped buying sovereign bonds. The spreads, he says, are simply too attractive to ignore after a rout that sent the benchmark yield to its highest since 2014.
“This month is when we will see the peak bond yield,” Mehta said in an interview in Mumbai. Mehta expects the yield to drop as much as 75 basis points by the end of March. But there’s one big caveat: that nothing dramatic happens in global markets.
The spread between the RBI’s policy rate and the 10-year bond yield — a key metric tracked by bond traders — is currently at 157 basis points. That’s far above where it should be, even discounting further jumps in the oil price and another rate increase, Mehta said.
Bond yields have risen relentlessly since over the past year, climbing for 10 of the past 11 months. Yields are up 49 basis points in 2018 on increasing fears of fiscal slippage ahead of general elections in 2019, surging crude prices fanning inflation, and a central bank in a tightening cycle. The 10-year yield was up 2 basis points to 7.81 percent on Monday.
Mehta, a self-described structural bond bull, says this year’s market has been the “most difficult” in his career. But he remains optimistic because he says prices can’t continue at current levels. “People have been very focused on what’s happening to the oil price, inflation, blah, blah, blah,” he said. “Rate hike, rate cut, no rate hike, pause, whatever it is. I’m not really looking at any of this. If you look at our policy rate at 6.25 percent and benchmark bond yield at about 8 percent, it’s way off.”
Aside from the spreads, Mehta says the bad loan overhang at Indian banks is showing signs of improving, because the government is now recognizing the issue. That’s another positive for bonds, he says, as state-run banks, the biggest buyers of sovereign debt, have stayed away from the market because of fears of adding to their mark-to-market losses.
India’s lenders, struggling with $210 billion of stressed assets, are under pressure to clean up their books as Prime Minister Narendra Modi attempts to restore loan growth in Asia’s third-largest economy. The country is closing in on Italy for the dubious distinction of having the worst bad-loan ratio among the world’s major economies. Bad loans at lenders are set to climb to a near two-decade high, by the central bank’s own estimates, underscoring the magnitude of the task.
“The problems are now being recognized at the ministry level,” Mehta said. “They are getting enough traction. That should change the situation.” While Mehta has made a habit of predicting big changes in India’s markets, his own career has been characterized by constancy. In fact, he has spent his entire career at one company, starting out at D.S. Prabhudas & Co. in 1988 and staying with it as it went through multiple iterations before finally becoming Bank of America Merrill Lynch in 2009. “I never changed my job,” he said. “My shareholders changed five times.”