Yields on the US 10-year Treasury note have plunged lately, falling to 2.2%, well below the levels they had reached a month ago, as chart 1 shows. US data has been downbeat recently, with retail sales weak in March, while consumer prices in the US dropped 0.3% month-on-month. That has led to Fed Fund futures pointing now to a less than 50% probability of the US central bank raising rates at its June meeting. The US 10-year bond yield is now back to where it was in mid-November.
Lower bond yields in the US have supported emerging market (EM) equities, as chart 1 indicates. This month (till 14 April), while the MSCI US Index is down 1.4%, the MSCI EM Index has been flat, in dollar terms.
But while EM equities have been supported so far, it all depends on why US yields are falling.
Analysts have attributed part of the fall to Donald Trump’s signalling that he wants lower interest rates and a weaker dollar. Some of it, they say, may be a knee-jerk flight to safety on the heightened tensions in North Korea and jitters over the French elections. And part of it is due to concerns that the US reflation trade is dead in the water.
Action on the gold front suggests that investors are hedging their bets. Chart 2 shows that while bond yields have fallen, the price of gold has risen. Indeed, gold prices have risen to their highest level since Trump’s election as US president. If indeed investors are piling into US bonds and gold on account of rising geopolitical tensions and a flight to safety, that suggests EM equities too could be coming under pressure soon.
If on the other hand, as is more likely, the geopolitical scare dissipates and bond yields stay down due to a weaker US economy, then it would mean more money for EMs and a buying opportunity. In India at least, most investors are betting on the latter scenario.