Rising US yield, weakening dollar are everyone's problem, says KIE

KIE flags rising tremors in US debt and dollar that could rattle global markets

The recent jump in US bond yields, driven by weakening US macroeconomic fundamentals, is sparking concern about broader effects on global economies.

 

A report from Kotak Institutional Equities (KIE) explains that higher yields reflect bond markets pricing in a ballooning US fiscal deficit alongside mounting macroeconomic and policy uncertainty. This has pushed investors to demand steeper returns to offset growing risks, potentially straining the US fiscal and debt outlook as new bonds are issued at elevated rates.

 

The 10-year US Treasury yield climbed 24 basis points (bps) to 4.4 per cent in May. Meanwhile, the yield on the 10-year Indian government security dropped 15 bps to 6.2 per cent last month.

 

According to KIE, the impact of rising US yields may be limited in some economies, including India, where the Reserve Bank of India (RBI) is expected to remain focused on domestic growth.

 

India’s bond yields currently maintain a “decent” premium over US yields, supported by a stronger macroeconomic position — including a low current account deficit, a comfortable balance of payments, moderate inflation, and a fairly valued rupee, the report notes. These factors give the RBI room to prioritise growth over external pressures.

 

However, a weakening US Dollar Index (DXY) could have far-reaching consequences, the brokerage warns. 

 

The KIE report highlights that the dollar’s “safe haven” reputation has long obscured underlying vulnerabilities in the US economy. Historically, excess savings from Asia and Europe have funded US consumption, driving capital into US assets.

 

A declining DXY could disrupt this dynamic, forcing adjustments such as reduced US consumption, increased domestic production, or higher yields to retain foreign investment, observe KIE strategists Sanjeev Prasad, Anindya Bhowmik, and Sunita Baldawa.

 

For non-US investors, a weaker DXY may prompt a reassessment of US holdings, risking losses for those heavily exposed.

 

The report outlines three possible outcomes: higher US yields to retain foreign capital; increased investment in home markets (which risks inflating asset bubbles); or changes in saving and spending patterns in “saver” countries across Asia and Europe.

 

Emerging markets, including India, may not benefit automatically from these shifts, the report cautions.

 

A realignment of global capital flows could lead to volatility, with uncertain consequences for global markets.

 

As the US wrestles with fiscal strain and a weakening dollar, the ripple effects may reshape investment decisions and economic priorities worldwide.