What is causing the global bond sell-off?

WHEN GLASS-HALF-EMPTY types look at bond yields surging around the world, they blame feckless politicians. In America, Donald Trump is presiding over huge deficits and trying to bully the Federal Reserve into easy money. Politicians elsewhere are similarly blasé about borrowing, and only a bit less about central-bank independence. Higher yields reflect, on this theory, investors’ alarm that all this will lead to higher inflation.

The glass-half-full view, championed by America’s treasury secretary, Scott Bessent, is that bond markets are reacting to prospects of faster long-term economic growth. The artificial-intelligence revolution will raise productivity in the future but needs plenty of capital in the present to build data centres and electricity generation to power them. The public sector is thus competing for money with the private sector.

One test of the two theories is India. The yield on ten-year Treasuries is up by 0.67 percentage points this year, to 4.8%. That on the equivalent Indian government securities (Gsecs) has risen by 0.37 points, to 7%. That spread remains near historic lows. Whatever is causing bond yields to spike is having less of an effect on the world’s largest democracy than on its oldest one. Why?

Growth in India is blistering. In the second quarter GDP expanded by 7.8% year on year; the figure for the preceding three months was 8.6%. Private investment shot up by nearly 12%. The Centre for Monitoring the Indian Economy, a private data-compiler whose numbers market-watchers trust more than the official ones, reckons new projects, particularly data centres and nuclear-power plants, were up by 27%. If exchequers are competing with a newly capital-intensive private sector then Gsecs should be feeling it more than many rich-world bonds. A wicket against growth theory, then.

What about economic policy? Early during the recovery from the covid-19 pandemic in 2020 and 2021, rich countries ignored inflation risk and overstimulated their economies. Poorer ones, by contrast, raised rates swiftly and were less profligate. Once you strip out a few defaulters, the spread between poor-world debt and Treasuries is the narrowest since early in the global financial crisis of 2007-09.

India is a case in point. In the decade since the Reserve Bank of India (RBI) has had an inflation target (of 4% plus or minus two percentage points), prices have risen by an average of 4.6% a year, compared with 8.1% in the previous ten years. The primary fiscal deficit (before interest payments) is back below 2%, near where it had fallen before the pandemic forced governments everywhere to spend more. This year the government is raising subsidies for fertiliser and fuel, whose prices have rocketed owing to the war in Iran. But it may offset some of this with revenue from privatisations of some large state-owned firms. A run for the rich-world institutional-decay hypothesis.

Test match over? Not quite. The Indian bond market is, as in many other large emerging economies, full of captive investors who have no choice but to lump it and accept lower yields than they would like. Big domestic buyers of government bonds, such as life insurers, banks and pension funds, do not have the option of shifting capital out of the country. Much of the $127bn that the RBI has attracted to Indian banks with a scheme that subsidises foreign-currency deposits of non-resident Indians will be parked in Gsecs.

And since getting capital out of India is hard, foreign investors are reluctant to provide it in the first place. Only around 3% of Gsecs are owned by foreigners. This means that the government need not overly worry about bond vigilantes.

Rich countries may look at all this and conclude that the way to contain bond yields is to meddle in capital markets. Ahead of America’s midterm elections in November, Mr Bessent has tried to lower long-term yields, which determine the interest rates on things like mortgages, by announcing that the Treasury Department would buy up more long-dated bonds.

That is precisely the wrong lesson to draw. India’s experience shows the importance of cleaning up public finances and letting central bankers fight inflation in peace. It is also trying to attract more foreign capital, even introducing a tax break for bond investors. The country may be an imperfect test of what is going on with bonds. But it shows that institutions matter—and that investors know it. ■