Recently, soaring bond yields have triggered fears in capital markets around the world. But are soaring bond yields really bad for the economy? Well, let’s find out.
Crux of the Matter
Relationship Between Bonds And Yields?
Rising bond yields have sparked fears in the equity markets globally mainly because bond prices and yields are inversely related.
In Case Of Fall
When interest rates rise the value of the bond will fall and the value of investments related to the interest falls. But bonds that have already been issued continue to pay the coupon amounts, thus becoming attractive and are sold at a premium.
In Case Of Rise
When interest rates rise, new bonds will pay higher than existing bonds making the price of older bonds fall for compensating, and are thus sold at discount. Also, future earnings of companies get discounted at a higher rate due to which present value of earnings falls and which is why equities fall.
How Does Bond Yield Affect Government’s Borrowing Programme?
- When the bond yields rise, RBI has to offer higher cut-off price or yields to investors.
- Recently the yields on a single day rose by 10 bps (0.01%) as RBI rejected bids because traders demanded higher yields.
- RBI has a tough task ahead to stabilise yields at around 6% as government plans to borrow nearly ₹12 lakh crores in the upcoming fiscal.
- So far, in FY 21 RBI has bought ₹3 lakh crores worth of bonds.
- But as government borrowing costs are used as a benchmark for pricing loans to businesses and consumers, an increase in yields will be passed on to the real economy.
- As the inflation and economy will rise, investors will move to safer investments, making bonds attractive and will dump equities.
- Fifteenth Finance Commission has proposed to bring down the Debt-to-GDP from 89.8% in FY21 to 85.6% in FY26.
Bad Signals From The US
- As the Biden administration passed its $1.9 trillion package, yields are ought to rise. This will be bad news for India since it will decrease the FPI inflow.
- As the US yields rise further and go near 2%, FPIs will pull out their money from emerging markets across the globe.
- In the coming months, Fed is expected to increase the interest rates which will eventually increase the yields.
Rising yields in India and around the world will not necessarily be bad. A small term correction is inevitable but looking at the growth prospects of India, markets are ought to grow in the long run.
As per a report by Morgan Stanley:
- In the past 20 years, there have been 4 major rising yield cycles and each of them has been positively correlated to equities.
- For equities, the gap between long yields and estimated real growth matters. If this gap rises, equities generally do well.
Summachar brings you this story in collaboration with Finmedium that can be found on Instagram at @finmedium and on the web here.
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- Live Mint – When It Comes To Bond Yields, RBI Cannot Have The Cake And Eat It Too
- Economic Times – Cost of borrowing to be reasonable; yields expected at around FY21 level: DEA Secy
- XTB – Price and Yield – An Inverse Relationship
- Fidelity – Bond Prices, Rates, and Yields
- Business Standard – Explained: How bond yields impact stock market & what should investors do?
- The Indian Express – Rising bond yields a trigger alarm for other asset classes
- The Indian Express – Explained: What rise in bond yield means for investors, government