Impact: Positive (Bond Prices)

Calculations based on India’s zero coupon yield curve (ZCYC) indicate that 10 year forward yields have declined by 82 bps since September 2018. This is very much in-line with our expectations and incorporates high FPI inflows in recent months along with lower rates. We see the lack of credible inflation in the American economy influencing the US Fed’s decision to normalize – an event that is significantly impacting FPI inflows into India. The Fed now expects no hikes in the calendar year of 2019, giving a breather to emerging market debt, which is experiencing higher demand.

Indian 10-year forward in March 2018 (before the rate hike) stood at 8.05%; eventually the yields climbed to 8.36% in September 2018 after the two rate hikes. Once the Fed’s stance became apparent, inflows materialized and suppressed the yields to 7.54%, as on March 25th March 2019. We expect the yields to further decline to 7.37% by September 2018 despite upward pressures emanating from significant safe haven demand for US long term debt.

We understand that the inverting of US yield curve is purely financial in nature and may not be a sign of recession. Consequently, however, demand for American long term debt will remain high and maintaining an attractive spread will be a challenge for Indian asset classes. In the medium term, this may lead to a flight to safety kind of situation for emerging markets (including India), which are also fighting deflationary conditions. Rates and domestic inflation will therefore be another dimension worth considering as yields will follow rates.

Source: Acuité Research; CCIL