HeftofbondmarketsandJamesCarville

The American political and economic Strategist James Carville once said that if given a chance to reincarnate, then in the next life, he would like to come back as a bond market as you can intimidate everyone by being that. Carville is known for coining the famous slogan “it’s the economy stupid” in 90s which helped the Democrats to ascend the presidential throne post the gulf war induced economic downturn. His pithy description of bond markets is insightful and relevant in the current context where the rising yields have left the central bankers worried whether they are in US, EU or India.

In India, the Central Bank Governor in an interview yesterday stressed about the importance of the orderly evolution of the yield curve. He also pointed out that the RBI has given a very clear signalling to the bond markets since last year. He said that even in the wake of higher borrowing by government, the RBI’s job is to ensure that it gets carried out in a non-disruptive manner. On the OMO issue he clarified that the RBI has done 3 lakh Crore INR so far and there is no reason to believe that it will not repeat the same in next year. Couple this with the space generated because of HTM rule changes, he believes that the net borrowing requirement of 9 lakh crore INR of GOI is very much manageable. The 10-year benchmark INR bond yield is trading at 6.16. The 10-year US treasury yield is trading at 1.40 up 6 bps from yesterday.

Now let’s pause for a minute and think about the impact of rising yields. Any new debt which gets issued by the government is priced at a higher yield increasing the cost of borrowing. We witnessed some of the primary auctions getting devolved in the recent days owing to the high yields (impact is circular, high cost, high interest burden, higher deficit feeding into higher cost). The next step is corporate borrowing which is generally at a premium to the government yields owing to the default risk, it will also witness higher cost. The retail loans also get costly reducing demand for goods and housing. The slowdown in demand feeds into the economic mood abetting a downward spiral of job losses and growth slowdown. The other asset classes like equities also especially the stocks of new age industries where the cash flows are in distant future have to be discounted at a higher yield driving their prices down much more in comparison to the traditional industries which have visible cashflows. Hence, we can see a clear causality flowing from the bond markets to every other corner of the economy appreciating the message of Carville statement.

In other news, Dow Jones ended in green yesterday. Hang Seng is up 2%, Nikkei is up 1.5% in the morning trade today. Dollar Index is trading below 90. Offshore Chinese Yuan is trading at 6.45 whereas the Pound and Euro continue their good run against the US Dollar. The South African ZAR also appreciated post the budget announcement yesterday. The global mood remains of relative risk on where the near-term easy liquidity looks as confirmed by the statements put out by Central Bankers. It remains to be seen that how quickly these verbal interventions need to be turned into real actions.