India, US bond yield spread at near 2-decade low, may impact foreign flows

By Dharamraj Dhutia

MUMBAI, Dec 19 (Reuters) - Spreads between India and U.S. bond yields plummeted to their lowest levels in nearly two decades in the aftermath of the Federal Reserve delivering a hawkish rate cut at the end of its policy meeting on Wednesday.

U.S. yields surged while the slower pace of rise of Indian yields led to a tighter spread or the interest rate gap between the two countries.

WHY IT'S IMPORTANT

Indian bond prices have stayed supported through the last 12-15 months on robust foreign inflows after the announcement and inclusion in JPMorgan's emerging market debt index.

Higher interest rate differential was also a major factor for foreign investors going overweight on Indian debt.

A wider gap is essential as it rewards foreign investors to undertake investment in risky assets.

CONTEXT

The Fed expectedly cut rates by 25 basis points but slashed guidance for rate cuts in 2025 to 50 bps, down from 100 bps earlier, and raised its inflation forecast, leading to a selloff in domestic and global treasury markets.

The cautious Fed guidance is seen in the light of Donald Trump taking over the U.S. Presidency from January, and his policies that are deemed inflationary.

MARKET REACTION

The 10-year U.S. yield rose 13 basis points to its highest level in nearly seven months and was at 4.52% in Asia hours on Thursday. The 10-year Indian benchmark bond yield rose 5 basis points to 6.79%.

The spread plunged to 227 basis points, the lowest since May 2006, and has halved in just over two years.

GRAPHIC

KEY QUOTES

"With the 10-year U.S. yield at 4.50%, sovereign bond yields may become unattractive and foreign investment in such papers may slow down, with investors looking to chase higher yields," Mandar Pitale, head of treasury at SBM Bank India.

"Elevated U.S. yields, strong dollar and risk of RBI allowing rupee to finally align with peers will weigh on flows... Only modest flows should be expected," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

(Reporting by Dharamraj Dhutia; Editing by Eileen Soreng)