U.S. Treasury Yield Spike May Slow Foreign Inflows Into Indian Bonds Market

There are few reasons for the Indian debt market to panic as of now, in reaction to the U.S. Treasury yield reaching nearly 5% on Thursday's overnight trade, according to experts.

Foreign fund inflows may see some slowdown into Indian government securities, but not for too long, as inclusion in JP Morgan's bond index comes into effect in July 2024.

The 10-year yield on U.S. Treasury securities closed at 4.98% on Thursday, marking a 16-year high, fuelled by expectations that the U.S. Federal Reserve will keep interest rates higher for longer in an effort to cool inflation.

"The recent surge in nominal long-end yields has been led by increased supply in recent quarters, higher real yields contributing more than inflation expectations, and Fed repricing and soft landing narratives, leading to higher term premia," said Madhavi Arora, lead economist at Emkay Global Financial Services Ltd., in a note.

Additional interest rate hikes could be warranted in view of economic resilience and labour market tightness, said U.S. Fed Chairman Jerome Powell in a widely anticipated speech at the Economic Club of New York. The central bank would be “resolute” in its commitment to its 2% inflation mandate, he said.

Indian government bonds, in reaction to U.S. Treasury yields, opened flat at 7.37% on Friday.

It is important for the U.S. bond yields to "hold on" to ensure calm in the Indian bonds, according to Lakshmi Iyer, chief executive officer of Kotak Alternate Asset Managers Ltd.

Iyer sees U.S. Treasury yields peaking at around 5%.

"Indian bond yields are already acting northwards in response to the U.S. Treasury yield heading upwards and the expectations of impending open market bond sales by the RBI," Iyer told BQ Prime. "For foreign investors, given the narrow gap, there is still merit in looking at U.S. bonds at the current juncture, given their inverted nature," she said.

This sentiment was echoed by Amit Shewale, an independent macrotrader based in Mumbai. Shewale sees some slowdown in active foreign inflows into Indian bonds going ahead.

"If you look at the spread of the Indian 10-year bond yield versus the policy rate, it is not very high in comparison to what we have seen historically," Shewale told BQ Prime. "There have been times when the 5-year bond swap spread has been around 100 bps higher. In that sense, I would say Indian bonds are not so cheap."

Market traders peg the resistance for Indian government securities at around 7.45–7.50%, where domestic traders may resume some buying.

Besides, geopolitical conflict in Israel, movement in crude oil prices, and supply factors in the U.S. Treasury will also affect the sentiment for Indian bonds, according to Venkatakrishnan Srinivasan, founder and managing director of Rockfort Fincap LLP.

"We don't see any material impact on Indian bonds yet. We see 7.40% and 7.45% as two major breaks for the India 10-year, where we will see domestic bond buying. Once that buying happens, the yields will remain range-bound," Srinivasan said.