Markets on tenterhooks: India-US bond yield spread lower than 5-yr average

Indian equity investors should brace for more volatility in the market. Bond yields in the US are rising faster than India, leading to the possibility of a rapid catch-up here, keeping Dalal Street on tenterhooks in the coming weeks.

10-year treasury yields in the US are up nearly 50 basis points (bps) in the past two months or up 20 per cent on the base yield of 2.36 per cent at the beginning of December 2017. In the same period, 10-year treasury yields in India went up by 52 basis points or 7.4 per cent on the base yield of 7.06 per cent at the beginning of December.  
 
As a result, the yield spread on Indian treasuries over US treasuries is now down to 4.7 per cent against a five-year median yield spread of 5.8 per cent. In other words, bond yields could possibly rise by another 100 bps to maintain the historical gap in the yields in India and the US.
 
For example, when bond yields had last hit three per cent mark in US in December 2013, treasury yields in India had hit nine per cent. (See table)

Analysts say higher bond yields translate into lower stock prices as it compresses the spread of earnings yields over bond yields, reducing the attractiveness of equity over fixed income assets. Earnings yield is calculated by dividing a company’s trailing 12-months’ earnings by its stock and denotes the potential yield for an investor if the company distributes its entire profits as equity dividend. The earnings yield is currently around four per cent for the BSE Sensex stocks.
 
Higher bond yield also pushes up borrowings costs for corporates, raising capex cost and hitting corporate earnings by way of higher interest payments.