After several rounds of rate hikes in the last three years, bond yields which track interest rates, are trading 30-50 basis points (bps) below their recent highs. Stock indices, on the other hand, despite facing a hawkish central bank, are now at lifetime highs across the US, Europe and India, which limit the equity avenue of investing. Investing in bonds in the current high yield environment also offers a scope for price appreciation on an eventual rate cut as when market yields decline following a rate cut, price appreciation ensues for existing bond investors.

While Indian bonds are the obvious choice for many, Bandhan AMC has launched an NFO (closes on February 27), which will invest in US Treasury bonds. Bandhan US Treasury Bond 3–7 year Fund of Fund (FoF) NFO is an open-ended fund that will invest in index or ETFs of funds which invest in US Treasury securities of three-seven year maturity.

Here we analyse the case for US bond investing over Indian bonds and the relevant macroeconomic factors at play.

Yield comparison

As stated, Indian bonds of three-, five-, or seven-year maturity are currently priced to yield 7.05 per cent, 7.08 per cent, 7.06 per cent which is well over US Treasury bonds yielding 4.45 per cent, 4.3 per cent and 4.32 per cent. But for an Indian investor, currency depreciation is an additional factor over US Yields. From 2015 to 2024 January, the Indian Rupee has depreciated 3 per cent per year, which is roughly the difference between the bond yields. While past rupee depreciation is not a reliable measure of the future, a developing nation with export focus can be expected to maintain a currency depreciation, excluding any extraneous circumstances. But over and above this assumption, the volatility of currency returns in a short-medium term period is also an unknown. The currency depreciation should deliver in the investing period, which makes the equilibrium condition speculative for the investor in the period of exposure.

Rate-cut scenarios

A rate cut expectation is just that, at the current juncture - an expectation! Unless inflation, supply chain disruptions and global growth rise or fall to expected levels, central banks will remain cautious. On the other hand, high interest rates are expected to normalise, with consensus building in a reversal in the next six, nine or 12 months.

If and when rates reverse, India may not necessarily change regime immediately, as rate cuts in US allow a certain elbow room for other central banks unlike rate hikes. This implies that US Bonds may gain faster than Indian bonds on eventual rate hike. In the longer term as well, Indian bonds have not cratered as sharply as US Bonds, going by yield increase. For instance, US three-, five- and seven-year bonds’ yields rallied from 1.0 percent, 1.26 per cent and 1.43 per cent in January 2022 to the current rates gaining an astounding 312 bps on an average in the period. Indian bonds of the same maturity and in the same period gained only 127 bps. Also, the gap to developed US market bonds and Indian bonds has significantly narrowed from 450 bps to 270 bps now. This follows US Fed hikes of 550 bps in the past three years, whereas the RBI did only 250 bps, lowest in the world.

Considering the delay in implementing a rate cut and the magnitude of correction undertaken by the RBI, a rate reversal might witness a higher yield decline and hence price appreciation in US bonds, compared with Indian bonds.

On the whole, Indian bond investing might offer a simple-high yield investment with scope for price appreciation. But for the risk-inclined investor, the arbitrage opportunity in rate-cut scenario combined with rupee depreciation make US bond investing an interesting avenue as well.

Investors with a dollar-denominated exposure in the medium term and willing to speculate on rate-cut scenario can consider the NFO.

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