Ten year US Treasury (UST) yields have surged by 50bps over the last one month and at yields of 2.22% are trading at highest levels seen since April 2012. On the other hand Indian ten year bond yields have dropped by 35bps over the last one month and at 7.15% levels are trading at the lowest levels since September 2009.
Ten year UST yields have risen by 17bps in the last two days on strong economic data coming out of the US. US home prices jumped by 10.9% year on year in March the most since April 2006. US Consumer Confidence for May 2013 climbed to its highest level since February 2008. US equity indices are at record highs while the USD index has risen by 10% over the last two years.
USTs are reacting to the prospects of a good recovery in the US economy. The bond market is staring to factor in easing of monetary stimulus by the Fed. Fed has indicated that it will consider scaling down its bond purchase program in its next few meetings.
Money is moving out of safe haven USTs to riskier assets of equities and even high yield bonds.
Indian ten year bond yields that have dropped sharply over the last one month is seeing some profit taking over the last two days on the back of rising UST yields and a falling INR. INR is down to below Rs 56, levels that it last touched in June 2012. INR is reacting to the strengthening USD on the back of strong US economic data. The benchmark ten year bond the 7.16% 2023 bond has seen its yield rising by 5bps from lows over the last couple of days.
The question is will the 7.16% 2023 give up more yields going forward on the back of rising UST yields? The answer is no, the 7.16% 2023 yields will not follow the UST yields upwards as the factors driving both the yields are different. In fact the 7.16% 2023 will see yields dropping as demand for government bonds stays strong in the system.
The 7.16% 2023 bond yield is driven on expectations of RBI lowering the repo rate in its June or July 2013 policy reviews. Indian economic data has been bond positive with inflation at three and half year lows and GDP growth at decade lows. The government is lowering its fiscal deficit in 2013-14 to 4.8% of GDP from 5.2% of GDP seen in 2012-13. Government cash balances are healthy with around Rs 100,000 crores parked with the RBI.
FII interest in government bonds are high with last two limit auctions of a total of USD 6 billion held in April and May 2013 being full bid. FIIs have bought USD 2.7 billion of debt over the last two months and are likely to buy more debt going forward. The spreads offered by the ten year government bond over the ten year UST is attractive at 500bps and as money moves into risk assets this spread can come off in the months to come.
A look at the yield movements in ten year bonds (See Table 1) of various countries indicate that India, Portugal, Greece and Italy have seen yields drop while every other country has seen yields rise over the last one month. Money is clearly moving out of low yielding bonds to high yielding bonds and this trend will continue going forward.
Table 1: 10-Year Government Bond Yields