Bond yield and economy

What is bond yield

Generally, people keep an eye on the stock market to understand the economic position of the
country but real barometer for economic stability is the bond market.

Dalal street pays attention to US and Indian bonds and compare rate on short term and long term
interest rates. These are plotted on a graph with yields on the y axis and years on x axis, the
supposed graph is upward slopping curve, the higher rate for the longer term bond compensates an
investor for the greater risk that inflation will chip away some of its value with time.

Higher long term rates projects that growth will continue but when the spread narrows its signals
that people are not convinced that growth is here to stay.

Long term rates are low and are slow to react to feds change in interest rates where else short term
bonds have an immediate effect.

The inversion

inverted yield curve on bonds is when the yields on bonds with shorter duration are higher than the
yields on bonds that are longer in duration. This abnormal situation that often signals an impending
recession. In a normal yield curve, the short-term bills yield less than the long–term bonds. If yield
curve inverts it signals that the investors demand more yield in the short term cause the tend to
believe the risk in short term bond is more than that of long term, they prefer to buy long-term
bonds and tie up their money for years even if the receive low yield, and this is only done when the
investors believe that in near term the economy is going to tank.

Why yield curve inverts

As investors move to long term bonds their yield tend to fall because the are in demand now, so
they don’t require high yields to attract investors now. And now demand for short term bonds tend
to fall, they need to pay higher yield to attract investors. Eventually, the yield on short term rises,
higher than the yields on the long term bonds and the yield curve inverts.

Recessions last for atleast of 18 months so investors tend to buy bonds more than of 4 years this
tend to invert the curve even more.

Current yield curve inversion

1m 3m 6m 1y 2y 3y 5y 7y 10y
2.435 2.43 2.459 2.426 2.343 2.294 2.309 2.397 2.499
As on April 7 1month yield is more than that of 5 years and 7 years yield which indicate that the
investors believe economy will recover in 5-7 years
When the Inverted Yield Curve Last Forecast a Recession

The Treasury yield curve inverted before the recessions of 2001, 1991, and 1981.

The yield curve also predicted the 2008 financial crisis two years earlier. The first inversion occurred
on December 22, 2005. The Fed, worried about an asset bubble in the housing market, had been
raising the fed funds rate since June 2004. By December, it was 4.25 percent.

That pushed the yield on the two-year Treasury bill to 4.41 percent. But the yield on the 10-year
Treasury note didn't rise as fast, hitting only 4.39 percent. That meant investors were willing to
accept a lower return for lending their money for 10 years than for two years.

The difference between the 2-year note and the 10-year note is called the Treasury yield spread. It
was -0.02 points. That was the first inversion.

The rate on 2-year-old note is inching closer to that of 10 years, making that ordinarily upward
sloping curve and making the curve flat and leading towards so called inversion, from historical data
to prove there has never been a recession that was not preceded by an inverted yield curve. 2-year
bond has moved up than 5-year bond which has initiated the so called inversion.
Indian bond yield curve

Indian bond yield has little kinks but its slope indicates normal yield curve.

Effect of yield curve invention of US in Indian economy

Mild slowdown in the US is good for these inflows. “FII inflows into India have slowed down during
the past four years, mostly because of the strong US economy. A weaker global growth is not bad for
India because Indian growth will look better
Fii inflow in equity

Fii inflow in debt

FII inflow has pushed up the rupee