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Fixed Income

US, Indian bonds Hit Year-High Yields, Markets Tank on Capital Control and Debt Exit Fears

Markets are down over 2% and Banks over 3%. There are reasons, and some of them were the capital controls imposed on Wednesday, and the fact that Chidambaram came on TV, which is typically a bearish sign, as I find out from traders at the conference I’m in.

Look first at the US 10 year yield:

US 10 year yield

(Source: Bloomberg)

And then, look at India’s 10 year:

India 10 year yield

(Source: Bloomberg)

And this is the 2023 bond. Literally every single other bond is trading at 9%+.

Finally, look at India’s short term T-Bill auction chart:

91 day T-Bill Yield

Note that this is a one-a-week auction, and it’s now going towards the 12.96 high we saw way back in 1995.

What’s really happening?

If there is a fear of a US Taper, then US bond yields rising means investors are selling bonds, on fears that the US Fed will stop buying.

That fear should propel exit from debt in other countries as well. If money flows out of US govt. debt, it will flow out of Indian govt debt as well. Foreign investors are exiting our debt markets – both corporate and government – largely on this global trend and fears of a taper.

While 11.5% is an interesting yield, the rupee depreciation – more than 5% in recent months – will have created a smaller net return.

Additionally, the capital controls and trading restrictions don’t allow easy mechanisms to hedge the currency risk. Already banks are restricted from forex exchange positions (on a proprietary basis) and they won’t be happy to take the risk on a longer term hedge if they can’t offset it easily. Capital control announcements create a fear that eventually they might restrict dollars from going out in any form, so investors want to move out before that.

If the rupee is falling (and it crossed Rs. 62 briefly today) then it really means the fear is materializing.

At this point, equity markets are hosed and banks are going to be hit even more. That is part of the game, so it’s nothing to worry about.

What is worrying though:

  • Will there be large FCCB or ECB defaults? The resultant litigation can take years, and it will determine future flows. (They need to declare and liquidate very fast)
  • Will the rupee fall hurt inflation and cause an official rise in interest rates? I think we should stop pretending we’re in rate cut cycle and get with the program. But you know how important pretending is nowadays.
  • Will short term (and long term) rates go much higher? It’s not much more to go for debt yields to hit 10% now, and T-Bill/CD yields are around 12%. This hurts credit offtake.
  • Will the Indian government and RBI stop knee jerk action? We need long term steps. Short term confidence cannot be created by imposing barriers. We absolutely have to liberalize. Judicial reform, labour reform and a removal of subsidies (oil, fertilizer, food bill etc) will help show we mean business. Tweaking with FDI will not.

On the market side, I would probably say non-debt taking exporters – most IT companies and pharma – should benefit. However, when people exit, even those prices could be hit.

Disclosure: I have both long and short positions in the markets.

  • Vidyanshu says:

    Chidambaram, Subbarao and the regular talking heads from the UPA – Rangarajan, Montek and Raghuram have been trying to hike rates, impose controls etc., while doing double speak and calling these measures short term and refusing to acknowledge that we are now in the credit tightening cycle phase. This will have severe adverse impact on debt and equity markets. I think its safe to say that market participants are smarter than the government and have understood the secular downward trend India is in now. Times are bleak going forward – massive inflation, job losses, equity and debt market collapse, rupee collapse and lots of bankruptcies and who knows Bank runs as well. India is getting into dire straits now…..

  • Nagarajan says:

    IMHO Capital Controls alone will not help. If they really mean business, they need to focus on Fiscal controls as well. With elections coming up soon, I am not sure if that will happen.
    Prepare for more Rs devaluation, and invest accordingly.

  • Gold Bug says:

    I am sure incompetent Debt Fund Managers would have been sleeping at their desks. Investors should have taken their own decision to protect themselves from these wealth destroyers. Still Gold, Real Estate and Vegetables (sic) offer value. I moved to Gold Miners on July 12th and now NAV is up 16.9% and expect it to give 25% in next few days.
    Next opportunity will be Gilt Funds (after all FIIs exit) till then Cash is king.
    Finally Equities panic bottom when Nifty P/E reaches 12

  • Gold Bug says:

    In 95/96 when T-bills were 12.9%, 10 Year G-Secs were 14.8%. Now we have to wait for G-Secs to hit some numbers close to 14% which should be fantastic opportunity. I expect this point to be reached on the day real QE tapering takes place. (Sep. or Oct or Dec ???)

  • Ramamurthy says:

    Dynamic Bond Funds are supposed to be safer as the Fund Manager can shift from/to Long Term and short term Bonds as demanded by the occassion.Now I see it is not happening. IDFC Dynamic bond Fund now shows a negative 6 months return.Why please?

  • Leo says:

    GUYs see the HNS on that 90 day TBILL it is approx 7% head and breakout is 8 9%
    it means US T note going to hit 8.1 % soon which means 5% more to go
    with monster debts u think people can get out of it .DEBT blow up has just begun
    SO stop saying nifty PE and all…THIS PE nonsense has been goin gon for years .Bottom is when there is no one there to sell.Every hedge fund is up their but with stocks and debt funds.Let this 3% odd US cross u will see something big .If it doesnt happen it will be a miracle