Improving economic outlook due to vaccine drive and recovery optimism comes with risks -- bond yields soar and investors seek compensation for inflation risk.
With optimism around recovery from the pandemic growing, and vaccination drive picking up pace with multiple vaccines now being offered, the economic outlook is improving rapidly. This comes with risks — rise in inflation and expectations of a change in the US Fed’s policy stance. As a result, yields have soared as bond investors seek compensation for inflation risk.
The new US Stimulus package is further aiding the rise in yields as it paves way for a faster re-opening and stronger economic growth. “Personal savings rate in the US has now stabilised at ~20% as compared to pre-covid cycle average of ~7%. Elevated savings will also help the economy to recover faster once the pandemic is under control and consumers start using the savings to spend on goods and services,” said Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities.
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The 10-year US Treasury yields have jumped from lows of 0.9% at the beginning of the year to 1.7% last week. During the lockdown phase of the pandemic, yields had tanked to as low as 0.3%.
Government borrowing gets expensive
Yields have shot up at a stage when the government of India was to borrow money from the market to meet its fiscal year borrowing targets. A recent report by CARE Ratings highlighted that weighted average yields have spiked to a 5-week high of 6.14% compared with 5.65% in the previous week. This is when the government still has to raise around Rs 84,000 crore from the market to meet its target of Rs 12.8 lakh crore.
Rising yields have forced the central bank to step-up its operations and facilitate the government’s borrowing. “Liquidity is driving a lot of macroeconomic parameters including government bonds yields,” Kunal Sanghavi, CFO, HDFC Securities, told Financial Express Online. “Lot of stimulus and easing in India and globally has led to inflationary pressure on the system leading to higher yields especially in government bonds where creditworthiness is higher along with regular & active RBI intervention in terms of open market operations and operation twist to provide stability and meet their objective of large borrowings from bonds,” he added.
Throughout 2020, low-interest rates, across the globe, helped push equities higher. Although now the situation could reverse if bond yields continue to march higher.