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On Monday (October 23), the yield on 10-year government bonds in the US, the benchmark for asset prices across the globe, rose to hit 5.02 per cent, its highest level since July 2007. Though the yield came down to 4.85 per cent later in the day, the rise capped a multi-week rout in bond prices as investors bet that the US Federal Reserve would keep interest rates at their current high levels for longer amid concerns over inflation spiking again due to high energy process.
In India, the yield on 10-year government bonds is already at a high of 7.38 per cent, a rise on 24 basis points in the last one month.
The US 10-year bond yield has now shot up by nearly 400 basis points from 1.01 per cent in 2020. Factors like rising crude oil prices, inflation risks and interest rate signals from the US Federal Reserve have contributed to the hardening of bond yields
A higher government borrowing is also a reason for the rise in bond yields. “Increased apprehensions surrounding prolonged elevated interest rates fuelled a continued upward movement in the US 10-year yield,” said Vinod Nair, Head of Research at Geojit Financial Services.
Further, robust US economic data has hardened expectations that the Federal Reserve is likely to keep rates higher for a longer period. Investors are also concerned about the US government’s huge borrowing plans. Despite the historic rise (500 basis points) in interest rates delivered by the Fed over the past 18 months, stronger than expected US retail sales, labour market and inflation data in recent weeks have helped push yields higher.
According to IFA Global, concerns over inflation spiking again due to higher energy prices seem to be outweighing safe haven demand. The ongoing Israel-Hamas conflict has added to the global uncertainties, especially on energy prices. If inflation is likely to rise, investors will demand higher yields on their bond investments.
Meanwhile, US Fed Chair Jerome Powell in his speech last week said that records suggest a period of below-trend growth and softening of labour market conditions are needed for inflation to reach the 2% target. Any evidence of persistently above-trend growth or of tightness in the labour market not easing could put further progress on inflation at risk and could warrant further tightening of monetary policy. This in turn will push up bond yields.
What does it mean?
Historically, it was observed the bond yields in other countries, including India, rose when US yields showed any uptrend and vice versa. However, the quantum of increase varies depending on domestic factors. India’s 10-year yield rose by 162 basis points from 5.76 per cent (July 10, 2020) while US yields jumped by 400 bps to 5.02 per cent.
The rise indicates that the cost of funds in the financial system is rising and interest rates are on the upswing. The rising bond yield means the government will have to pay more as yield (or return to the investors), leading to a rise in cost of borrowings. This will have an overall impact on the financial system, putting upwards pressure on the general interest rates in the banking system.
Analysts say that rising yields hint at expectations of sticky and higher inflation coupled with possibilities of a rate hike or status quo on interest rates. US Fed has hiked interest rates by 500 basis points from 0.25-0.50 per cent to 5.25-5.50 per cent since May 2022. In short, rising yields put severe pressure on an upward movement in interest rates. Rising yields can also trigger a flight of capital from bank fixed deposits to sovereign guaranteed bonds as the differential in yields widen.
The rise in bond yield means that investors are expecting a rise in interest rates and are therefore selling the bond papers they are holding. Since a rise in interest rates would result in decline in bond price of existing bonds (and thereby capital loss on sale before maturity), investors rush to sell those bonds so as to limit the capital loss. Debt investors are set to get impacted with this rise in yield.
When yields rise and bond prices fall, net asset values of debt funds which hold a sizeable chunk of government securities in their portfolios will also decline, because of the decline in bond price. Further, it will also impact corporate bonds which are priced higher than government bonds.
A bond is a type of loan made by an investor to a borrower – a company or an institution – for a fixed period of time in return for regular interest payments. The yield on bond is the return an investor expects to receive each year over its term to maturity.
For the investor who has purchased the bond, the bond yield is a summary of the overall return that accounts for the remaining interest payments and principal they will receive, relative to the price of the bond. The prices at which investors buy and sell bonds in the secondary market move in the opposite direction to the yields. Rising bond yields could also have a cascading negative impact on equities.
