12 Dec 2021

Government bonds are turning riskier than high yield bonds-Weekly Fixed Income Analysis

Inflation is surging across the world but interest rates are at zero percent levels or even negative in many countries. Central banks have lost the will to fight inflation and are instead watching asset prices move higher and add to inflation expectations. High yield credits benefit while government bonds are at high risk of price erosion.

author dp
Team INRBonds
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RBI left rates on hold in its policy review last week even the central bank acknowledged high sticky core inflation at 6% and above levels, surging global inflation and high asset prices. RBI governor Shaktikanta Das said that while inflation is high, concerns on growth outweigh all other destabilising factors including asset price bubbles.

 

US inflation rose to 4-decade highs of 6.8% in November while Eurozone inflation at 4.6% levels is also at multi decade highs. However with US Fed, ECB and many other central banks maintaining rates at record lows, the gap between inflation and interest rates is climbing and leading to rising asset prices including commodities, real estate and equity. Cryptos too are seeing huge traction as investors turn to speculation to realise any real returns, which is returns after adjusting for inflation.

 

The surge in inflation is unprecedented as it comes amidst a worldwide pandemic that threatens economic growth globally. Central banks have been on the back foot on growth since 2008 global financial crisis and have kept interest rates extremely low over an extended period stretching upto 12 years. Covid in 2020 pushed rates even lower and there seems to be no inclination to reverse policy to fight inflation.

 

Given that central banks are no longer fighting inflation, bond markets are clearly looking for real yields, which will come in the form of high yield bonds. Appetite for negative yielding government bonds will fall leading to higher yields and falling prices.

 

Country

Real Central Bank Rates(rate minus inflation)

Argentina

-14.10%

US

-6.70%

Turkey

-6.30%

Eurozone

-5.40%

Poland

-5.10%

Norway

-4.90%

Canada

-4.50%

New Zealand

-4.20%

UK

-4.10%

Denmark

-4.00%

Chile

-4.00%

Czech Rep

-3.30%

Peru

-3.20%

Australia

-2.90%

Sweden

-2.80%

Korea

-2.70%

 

Government bonds, SDL and OIS yield movements

During last week, 6.10% 2031 yield remained unchanged at 6.37% while 5.85% 2030 yield stood steady at 6.39%. 5-year benchmark bond, 5.63% 2026 yield lost 1 bp to 5.69%. 6.64% 2035 yield rose by 1 bp to 6.78%. 6.57% 2033 lost 3 bps 6.72%. Long-term paper, 7.16% 2050 yield rose by 2 bp to 6.96%.

 

The spread of 10-year bond over 5-year bond rose to 68 bps from 67 bps in previous week. The 15-year benchmark over 10-year benchmark spread came down to 35 bps from 38 bps, while 30-year benchmark over 10-year benchmark spread remained unchanged at 59 bps on weekly basis.

 

10-year SDL auction cut-off rose to 6.87% from 6.84% in previous week while spread came down to 48 bps from 51 bps in previous week.

On weekly basis, 1-year OIS yield remained unchanged at 4.25% while 5-year OIS yield increased by 1 bp to 5.33%.

 

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