US Treasury Yield soars to one-year high: Impact
Last updated: 18 Mar, 2021 | 05:40 pm
US 10-year yields have jumped to a one-year high of 1.749%, after the Federal Reserve raised its growth and inflation forecasts. The 10-year Treasury yield, a key benchmark for borrowing costs across global financial markets, rose as much as 0.096% to 1.749%. The chart below shows the rise in US Treasury yields.
Why are the yields rising?
- Yesterday, the Federal Reserve raised its median forecast for growth and inflation in the United States, anticipating that the $1.9 trillion economic stimulus will lead to quicker recovery.
- According to Fed’s latest estimates, the US economy is expected to grow by 6.5%, up from a December estimate of 4.2%.
- Ahead of Wednesday’s monetary policy statement, investors had started to factor in the possibility of the central bank lifting interest rates earlier than expected to combat inflation, as economic indicators pointed to faster recovery.
- The concern is that the US Federal Reserve will have to taper its bond purchases and consider interest rate hikes due to rise in inflation, similar to ‘taper tantrum’ witnessed in 2013.
- ‘Taper tantrum’ is a phrase used to describe the surge in the U.S Treasury yields in 2013. The surge had come after the Fed’s announcement of future tapering of its policy of quantitative easing, inroder to reduce liquidity in the economy.
Impact on debt funds
- India’s 10-year benchmark bond touched 6.20% last week. The average increase in government securities yields across 3, 5, and 10 years has been around 31 basis points since the start of the Union Budget on February 1st. Corporate bonds rated ‘AAA’ and SDL spreads have jumped by 25-41 basis points during this period.
- Due to their higher sensitivity to yield changes, longer duration funds have been the worst performers in the last 1-3 month period. Duration is the measure of sensitivity of a bond’s price with respect to changes in yields. The table below shows performance of debt funds across categories
Impact on Indian equities
- The Sensex and Nifty fell sharply, closing lower for the fifth session in a row on Thursday. The concern is that increase in yields would lead to FII outflows from Emerging Markets (such as India) to higher yielding US bonds.
- Partly, the investor sentiment was hit due to rising Covid-19 cases in the country. The Sensex closed 585 points lower at 49,216, while the Nifty closed 163 points lower at 14,558.
What should you do now?
- Stick to high-quality AAA-rated low duration funds and bonds. Prefer safety over high yields in this volatile market.
- There is a significant tax advantage in holding a debt fund for more than 3 years. For a more than 3-year investment horizon, an investor should prefer short duration (duration < 3) fixed income instruments over long duration.
- The interest rates are expected to bottom out and move higher over the next 1-2 years. Shorter duration funds are likely to outperform in this scenario, given their lower sensitivity to interest rate changes as compared to long-duration funds.
- Invest in equities in a staggered manner. Stagger your lump sum equity investments into smaller fractions before deploying into this market
- Stick to large caps and index stocks that are best suited to navigate the volatility.
- Keep your SIP’s running