The name is bond, treasury bond. And like the legendary Ian Fleming character in the James Bond spy series, treasury bonds are creating a flutter in global markets. I am referring here primarily to the US Treasury bond market, which at about $30 trillion is the single largest (geographic) asset class in the world.
Given the size of the US economy and the dollar’s continuing global dominance, the US Treasury market widely serves as the benchmark for all other bond markets. Some might argue that it also serves an important role in setting the price of risky assets around the world.
Like all governments, the US issues short-dated and long-dated bonds ranging in maturity from four weeks to 30 years. These bonds are priced along a ‘yield curve,’ with short-dated bonds typically yielding lower than long-dated bonds.
On occasion, this can get reversed, when short rates are high and long rates are low; this typically signifies an impending recession. The short-end of the yield curve is strongly influenced by actions of the central bank. The long-end is typically priced as a combination of factors, including perceived risk of price fluctuations during the duration of the bond, economic growth prospects, future inflation and the issuer’s fiscal burden (which is usually measured in terms of government debt as a proportion of GDP).
US long bond yields have risen sharply this year, up about 60 basis points (equivalent to 0.60 percentage points) on a year-to-date basis and about 70-80 basis points from recent lows. This translates to about a 10% decline in 30-year bond prices, a massive move for such a large market.
The proximal reasons for this dramatic shift are three fold. One, the extraordinary increase in debt funding for the artificial intelligence (AI) capital expenditure boom is making the issuance of all bonds including treasuries more expensive. Two, the total size of US national debt has crossed the psychologically important mark of $40 trillion. Three, the risk of persistent inflation has not abated since the US Federal Reserve has not been able to reduce inflation to its target of 2% since it began this rate cycle.
This rise in US long bond yields has been infectious. Japan’s long bond yields have reached their highest in 30 years and UK gilts also touched the highest since just before the global financial crisis of 2008. Indian long bond yields, both for the 10-year and thinly traded 30-year bonds, have moved a more modest 30 basis points year-to-date.
Amid these record moves, US Treasury secretary Scott Bessent has resorted to extraordinary intervention in global bond markets by announcing greater buybacks by the US Treasury and also assisting Japan’s effort to defend the yen.
These actions are beginning to lose steam, with markets ‘seeing through’ the intervention and yields returning to pre-intervention highs. Continuing hostilities in West Asia are keeping the uncertainty premium high on long-dated instruments.
The first to suffer collateral damage is the housing market in the US. Mortgage rates have seen a near one-for-one pass-through from bond yields. Consequently, home sales are below an annualized five million homes for a fourth straight year and housing starts are down 13% year-on-year.
Global bond markets have seen a sell-off, significantly impacting residential and commercial markets. Emerging markets have also been impacted, but those with large reserves have been able to cushion and manage the transmission.
The US government is not at any risk of defaulting on its dollar obligations (it can after all print dollars), but the price volatility of long bonds can have significant implications for everything from the US cost of borrowing to the economics of AI.
The circularity embedded in the AI ecosystem, which features high borrowings, heavy vendor financing, insufficient demand, weak current revenues and opaque unit economics, is likely to be the biggest risk that arises from long bond yield upmoves.
All this is bad news for India. The Reserve Bank of India will have little choice but to move at least pari passu with any Fed rate hike or risk further erosion of its currency value. India’s stock market has been underperforming for two years, with a dramatic 25% deficit year-to-date in dollar terms versus the S&P 500.
With virtually no presence in the global AI investment landscape, flows to India have been crowded out by both safe capital (given the higher yields) and risky capital (given the preference for the AI trade).
From a cross-border perspective, the best hope for the Indian stock market is to act as a relative hedge against the collapse of the AI bubble. Domestic flows continue through SIPs, but this has not prevented a market decline in local currency terms of nearly 8% year-to-date. The Indian market has been flat for a little over two years now.
The lesson for India is to keep chipping away at economic reforms, enabling the ease of business and deepening of profit pools. Contrary to the West, India, given its stage of development, must act with fiscal prudence. The dangerous trend of Indian states resorting to competitive economic populism does not augur well for India’s overall fiscal position. In the longer term, economic growth, inflation and long-bond yields will determine flows into the country.
P.S: “I used to think... I wanted to come back as the president or the Pope or a .400 baseball hitter. Now I want to come back as the bond market. You can intimidate everybody,” said American political adviser James Carville.
The author is chairman, InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand