Home World Business Market sell-off brings 10-year American treasury yield back in focus

Market sell-off brings 10-year American treasury yield back in focus

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The 10-year yield has been on an upward move for a while now, but it wasn’t expected to reach the level of 2.85%, anytime soon

Vivek Kaul  |  New Delhi  Last Updated at February 7, 2018 11:10 IST

Global market sell-off was triggered by a rise in in the United States. Wall Street’s and benchmarks had slumped over four per cent each on Monday, their biggest drops since August 2011. The author explains why the are rising and it’s likely impact on financial =========================================== Between December 2017-end and February 5, 2018, the 10-year American Treasury Bond yield rose by 45 basis points to 2.85%. Treasury bonds are issued by the US government to finance its fiscal deficit, which is the difference between what a government earns and spends. This jump in yields was completely unexpected and it caught everyone by surprise. The economists, as usual, got their forecasts majorly wrong. The 10-year yield has been on an upward move for a while now, but it wasn’t expected to reach the level of 2.85%, anytime soon. Take the case of Survey of Professional Forecasters carried out by the Federal Reserve Bank of Philadelphia (The American Federal Reserve system, unlike other central banking systems, is made up of 12 Federal Reserve Banks). In this survey, the forecasters expected the 10-year yield to touch 2.7%, during the second quarter of 2018, and 2.8%, during the third quarter of 2018. The Survey said that the 3% yield would be hit only by the fourth quarter of 2018. Nevertheless, economists and correct forecasts, usually don’t go together and that has been proven all over again. The question is why are the yields rising so quickly, and what does this have to do with the stock falling all over the world, over the last few days. The American government has cut the corporate tax rate. While this will mean a greater profit for American companies, it will also mean that the American government will collect lesser taxes and will have to borrow more in order to cover its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends. Because the government will borrow more, it will have to pay a higher rate of interest than it currently is.

The market also expects the Federal Reserve to now hike interest rates four times this year, instead of three times that it expected earlier. In the expectation of this, the 10-year American treasury yield, has been going up. The treasury yield is a benchmark for other kinds of lending, given that lending to the American government is deemed to be the safest form of lending. In the aftermath of the financial crisis that started in 2008 when the investment bank Lehman Brothers went bust, the Western central banks, led by the Federal Reserve printed money and pushed down interest rates. The hope was that people will borrow and spend more, and the economy would recover. What happened instead was that the big institutional investors started borrowing money at very low rates and invested that money in stock all over the world. This trade came to be referred as the dollar carry trade. And it drove, stock to higher levels over the last few years, all across the world, including India. With the 10-year yield expected to go up, the carry trade might become an unviable proposition for many institutional investors. The era of “easy money” is expected to come to an end. Hence, the investors sold out in droves across stock markets, all over the world, including India. This era of easy money has also been used by many corporates in the United States to borrow money, in order to buy back their shares and push up their earnings per share. Between, February 1 and February 6, the BSE Sensex was down by close to 5%. Of course, in the Indian case, the fall has also been accentuated because of the government imposing a 10% tax on long term capital gains on stocks, if the gains are greater than Rs 1 lakh. The question is will the stock keep falling? The answer to that can only be provided by knowing which way the is headed. In fact, as I write this, on the evening of February 6, 2018, the 10-year yield is quoting at 2.7%. The direction of this yield, will now decide which way the global stock sway. If it moves towards 3%, then more falls are on the way. If not, we will surely hear more and more market commentators in India say, the India growth story is still going strong. ===================================== (Vivek Kaul is the author of India’s Big Government—The Intrusive State and How It is Hurting Us.) Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

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