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Inverted Bond Yield & Signals To Recession

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Inverted Bond Yield & Signals To Recession
Abhishek Raja “Ram” - 06 October 2019
Bonds or Debt instruments that are listed on the exchanges get traded by buyers and sellers. At any point in time, a bond would carry a yield or a likely rate of interest or return that an investor is likely to generate if the bond is held till maturity. The yield keeps changing based on the prevalent interest rate scenario, prospects for economic growth, tenure of the debt, credit ratings and inflation.
A yield curve is a plot or graphical representation of the yields of bonds maturing across maturities – say from 3 months to 30 years. All listed bonds issued by governments, corporates and financial institutions carry certain yields. Usually, bonds with a longer tenure carry higher interest rates compared to ones that are issued for shorter timeframes. The idea is that the later redemption or gratification, the higher should be the interest offered.

What is an inverted yield curve?

In many western countries and even some Asian majors, the yields on long-term bonds are lower than those for shorter tenure debt instruments. Therefore, the yields curve now would be ‘inverted’. Data analysis suggests that historically an inverted yield curve has been a precursor to a recession. So, there are fears that the economy might enter into a recession in the next few quarters. We have to look at the possibility of a recession or a massive slow-down in the global economy in the backdrop of unprecedented technological disruptions worldwide, global trade wars, shift away from fossil fuels.

Why is the yield curve inverting?

Much of the blame has been put on the US-China trade war. When it started over two years ago, there was hope it would get resolved as both sides kept the talks going. But a deal hasn’t come through even as Trump has put off the latest round of tariffs on Chinese imports (video games, smartphones, laptops, toys) to December 15. Tariffs on tools, apparel and some footwear took effect on September 1. The trade tiff between the two largest economies is creating uncertainty and investors are rushing to buy US bonds, a safe haven.

Is India witnessing a similar situation?

No, but India’s economy is facing other problems. Its financial sector is grappling with trillions of rupees in bad debt and resolution of most cases is still slow. Fear of probe agencies over fresh bad debts and a liquidity crunch are hampering lending by banks. Even as the world talks about negative interest rates, India continues to see high interest rates. Its 10-year bond yield rose for the fifth consecutive session on Wednesday and closed at 6.6 per cent—a level last seen on September 24. The country is still the second fastest growing large economy.

Why negative yields and interest rates?

Investors are willing to buy bonds at any price to protect themselves against sell offs in other risky assets in case the fear of a recession materialises. The rise in bond prices pushes yields downward. Holding cash can be an alternative. But that too may not work in the case of many western countries. Indian bonds remained volatile over the past year or two on uncertainties over the maiden offshore sovereign bonds issuance. India's benchmark 10-year bond yield fell below 6.40 per cent last week (Previous Year it was 6.48 per cent) after finance minister Nirmala Sitharaman assured that the offshore bond issuance plan was on track. The Reserve Bank of India (RBI) board has recently meet in mid-August to discuss the issuance plan. Foreign portfolio investors (FPIs) have shifted from equities to debt in August FPIs turned net sellers in equities for the first time since January, according to the report. Tax proposals outlined in the Budget, including higher tax incidence on FPIs and high net worth individuals, in addition to levy on buybacks, dampened punctured some of the optimism in the equity markets, it added. "The sentiment was helped by renewed rate cut expectations; we look for a 25 bps cut at the August review," said the research report. Global cues are under watch.
The US Federal Reserve is widely expected to deliver a 25-bps rate cut on July 31. Cash conditions are in surplus of Rs 1 trillion and are likely to stay so ahead of the advance tax payments. The inversion in bond yield is an indication that the recession is coming. But do you think somewhere we need to be cognisant of the fact that commodity prices have remained low for a long time and if global liquidity times moves into soya, orange juice and other soft commodities which have been slightly benign, all the assumptions of Indian recession will go?
Central Government is trying their best to tackle slowdown. They have come up with stimulus package for Auto sector, they have announced mergers of banks etc but will this much save Indian Economy from Recession or slowdown will continue further? The answer lies somewhere in the future.
The author is a chartered accountant specialising in GST & Economics

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