Rally in stock markets is the result of a steeper yield curve

Rally in stock markets is the result of a steeper yield curve
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First Published: Mon, Mar 16 2009. 10 28 PM IST

Updated: Mon, Mar 16 2009. 10 28 PM IST
The Reserve Bank of India’s buying up bonds has had the desired effect on yields, which fell sharply on Monday. The rise in government borrowing and the reluctance of banks to subscribe to government bonds has led to a spike in yields on government securities. This, in turn, has led to a rise in the yields on corporate paper. For example, the yield on the 10-year corporate bond has moved up at least 100 basis points since the beginning of the year, according to Bloomberg data. If the government wants to continue priming the fiscal pump, it can either go in for monetization, or sell assets, or borrow abroad.
Also See Globally Higher Yield (Graphic)
India is not alone in seeing a rise in bond yields, which have risen in the US, Japan, as well as in many Asian economies. The rise is the consequence of higher government borrowing in all these countries as a result of fiscal expansion to combat the downturn. But while long-term bond yields have risen, short-term rates have fallen—the result of central banks lowering their policy rates. The upshot has been a steeper yield curve.
Interestingly, the steeper yield curve has been very good in shoring up the weak banks in the West. It is the job of banks to transform maturities, and by borrowing at the short end of the curve and lending at the long end, their net interest margins improve and they book a tidy profit. The result has been an improvement in cash flow and the recent declarations by US banks that they have started earning profits have been behind the recent surge in the stock markets. But while the steeper yield curve may improve profits, the real question is how much more of write-downs they will have to take, especially as the bad debts spread to the real economy and to credit cards, to commercial real estate and to exposure to places such as Eastern Europe. The Western banks are far from being out of the woods, which means the current sharp pullback, led by the financials in the Western markets, is likely to be yet another bear market rally.
Write to us at marktomarket@livemint.com
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First Published: Mon, Mar 16 2009. 10 28 PM IST
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