Global bond yields have, over the past few months, started to rise as markets expect inflation to perk up and central banks shift gears towards a more hawkish monetary stance. The United States Federal Reserve, a few months ago, declared its intent to start the process of unwinding its previous bond purchases and therefore shrink liquidity. US bond yields consequently spiked to 2.74 per cent. German treasury bills too have risen from 0.41 per cent to 0.77 per cent over the past twelve months, prodded by comments from Mario Draghi, the head of the European Central Bank, that future bond purchases by the ECB will begin to moderate. All of this is in the backdrop of robust economic growth in America at 2.3 per cent and in the Eurozone at 2.5 per cent last year. Since the global financial crisis, central banks kept credit markets functioning, bailed out banks and provided assurances to wobbly bond markets. Perhaps, the protracted era of bonhomie is coming to an end as the interest rate cycle begins to turn.
In India too inflation seems to be perking up. 10-year bond yields have jumped by 150 basis points to 7.6 per cent over the past few months. Rising crude prices, additional borrowings by the Government of India and a higher than provisioned fiscal deficit at 3.5 per cent of GDP, have sent markets into a flurry with investors dumping government securities. The budget announced a Minimum Support Price that the government would provide to farmers, at 1.5 times the cost of production. This together with somewhat generous assumptions on GST collections all point to higher fiscal pressures on the government’s balance sheet. Under these set of circumstances, it now seems unlikely that the Reserve Bank of India will have any sort of leeway to reduce interest rates further. On the contrary, a rise of 25-50 basis points before the end of the year now appears more plausible.
In a paper entitled ‘Irrational Exuberance – October 2017’, I argued that global asset prices including stocks, bonds and property, were frothing and a correction was perhaps overdue. In India too, equities had risen by 283 per cent following the collapse that shadowed the global financial crisis. Price earning multipliers of 24 for the Nifty 50 and 35 for mid-caps seemed a stretch, as companies were unlikely to match market expectations on future profits. The recent collapse in Indian equities, triggered allegedly by amendments on the treatment of long term capital gains tax, was really a reflection of inherent weaknesses in the props that supported the financial markets. The bubbles in bonds and equities have consequently begun to deflate.