Why US Treasury bond yields matter, what it means for Indian investors, and the impact on rupee

United States Treasury yields have risen to multi-year highs. The yield on 10-year US Treasuries has climbed to 5.34% (intra-day), surpassing its 2007 peak, and hitting its highest since early 2002. The 30-year yield has touched 5.6%, also not seen since 2002. This sharp rise in US Treasury yields has sent shockwaves through global markets, including India.

What is driving up the yield

Rising US bond yields mean investors are demanding a higher return to buy and hold that debt. This reflects concerns over the weak fiscal position of the US and the inflationary impact from steep oil prices. Investors anticipate rising government borrowing to meet the growing fiscal deficit, which will bring large supply of fresh bonds to the market. This excess supply pulls down bond prices, putting upward pressure on bond yields.

The US Federal Reserve, the country’s central bank, also raised its policy rate by 25 basis points (bps) in September to 3.75-4%. With rising oil prices feeding into inflation, expectations are that the Fed may need to keep interest rates higher for longer. Stronger-than-expected US economic activity also makes it less likely that inflation will ease any time soon, and is keeping bond yields buoyant. Besides, competition for capital from the private sector to fund heavy investments into artificial intelligence infrastructure is keeping yields bubbling.

How it affects markets

US bonds are perceived as the world’s safest and most liquid assets. They effectively set the price of money across the world.

A higher US Treasury yield raises the return available on dollar assets. This sets a high bar for return from other assets. Investors reassess the returns they require from other assets, including emerging-market bonds and equities. These assets must offer enough additional return over a US Treasury to compensate for the extra risks of holding an emerging-market asset, including currency risk. If they cannot, global investors may reassess allocations to emerging-market equities and bonds. This affects the flow of foreign capital to countries like India.

US yields are rising even as Indian bond yields have stayed relatively stable. This has narrowed the India-US bond yield gap to historic lows. A narrower spread makes it less attractive for global investors to hold rupee-denominated bonds, after accounting for currency risk.

Rising US bond yields also complicate the Reserve Bank of India’s policy choices. They make it more difficult for the central bank to consider rate cuts, even if domestic inflation is lower. While the Indian banking regulator may not follow the Fed in hiking rates, its freedom to pursue an independent monetary policy gets squeezed.

Impact on rupee

US bond yields are rising at a time when the rupee is already under pressure. If demand for dollars rises or capital flows out, emerging-market currencies, including the rupee, can come under pressure. India’s dependence on crude oil imports make this a particularly challenging situation. Every dollar of oil becomes more expensive in rupee terms when the currency weakens. When price of crude oil itself is rising, the added burden of weaker rupee makes imports even more expensive, stoking inflation.