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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.


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