High US Bond Yields: Will It Impact Your Portfolio?

The apparent reason for US yields moving up is that the US Federal Reserve has raised the interest rate significantly, by 5.25 percentage points.

Remarkable things are happening in the US. The yield curve has been inverted for a long time now, with shorter-maturity yield levels being higher than longer maturity ones. At one point of time earlier, the inversion between US 2-year and 10-year bond yield was almost 1%; i.e. two-year yield was that much higher.

What’s happening in the US?

The apparent reason for US yields moving up is that the US Federal Reserve has raised the interest rate significantly, by 5.25 percentage points. But there are other reasons for yield levels to jump. Earlier, other countries would buy US treasury bonds. Now, the two major holders of US treasuries, China and Japan, are selling. As an aggregate, overall foreign purchase of USTs, including purchase by others, is positive. However, the US has a huge fiscal deficit and is issuing treasury bonds big time. Against the volume of fresh issuance of USTs, net foreign purchase is a pittance.

There are certain cracks happening in the USA, which are not so visible. Apparently, its GDP growth is reasonably good and labour market data looks buoyant. However, interest rates are on the higher side.

Fed rate is 5.5%, 30-year mortgage rate is around 8%. Mortgage defaults and credit card receivable defaults are increasing. The impact of all this will be seen down the line.

Impact on your investments

Equity investments are driven by the India growth story. While there are global inter-linkages, our economy is largely domestic. Phases of buoyant growth earlier had a sizeable chunk of contribution from exports. This would be missing for some time, as global growth and US growth is projected to slow down next year. There are certain economies which are largely export-oriented, who would be impacted more on global slowdown. India would be impacted relatively less.

For equity valuations, there is a discounting rate applied on projected cash flows of a corporate. The risk-free rate is often taken as the US treasury yield level. With that rate moving up, and consequently the cash-flow discounting rate becoming higher, valuation levels would look different. But broadly, the India growth story remains intact, apart from some impact on exports.

On bond investments, we are at the peak of the RBI rate cycle and rate cuts are possible next year. JP Morgan has announced inclusion of 23 government bonds in their emerging market index, June 2024 onwards. This is expected to lead to inflows in G-Secs, from FPIs. There is a counter-argument that the differential between US and India sovereign bond yields are lower than earlier. While that is correct, when the differential was higher, even the investments by FPIs in our debt was miniscule.  Flows from abroad are positive for our yields coming down next year. While there are global inter-linkages between economies, our investment portfolio performance is driven largely by domestic parameters.

Refer: https://www.financialexpress.com/business/investing-abroad-high-us-bond-yields-will-it-impact-your-portfolio-3290580/

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