The obvious flaw in the perceived stability of any global macro template over the past few years has been this: the US is both the driver of global growth as well as the custodian for global financial conditions. Thus, the previous regime of low and stable dollar funding chasing growth in the emerging world has been upended by the escalation in the so-called US exceptionalism. In this template US has been driving global growth with the obvious implication that it has been the recipient for the largest amounts of global capital allocation. As a result, and with stronger growth lessening probability of significant monetary easing, US dollar and yields have risen thereby ‘exporting’ tighter financial conditions to the rest of the world; most notably to emerging markets (EMs). Prudent macro policies, over the pandemic and subsequently, have partly mitigated the effect from such tightening in EMs. However, as India’s own very recent experience shows, the effect has nevertheless been substantial. Thus, we have seen massive rupee liquidity destruction over the past few months largely on account of forex operations of the RBI. More recent proactive steps to shore up liquidity have helped, but are more of the nature of ‘running to stand still’ so long as the currency pressure continues.
Thus, a line of enquiry that has occupied a lot of our thinking since late last year is the so-called US exceptionalism trade and the likelihood of it turning. We had looked at a host of drivers (immigration, fiscal impulse, corporate capex, divergence in consumer behavior, extent of ownership of US assets, etc.) in a presentation put out in January (“Global and India Macro and Markets – Jan-2025” which can be found amidst the presentations available here: https://bandhanmutual.com/downloads/presentations ). While recognizing the hazards associated with calling time out on a major global theme, we had nevertheless concluded that the drivers of US exceptionalism may be running out of steam.
Since then, signs are clearer that US exceptionalism is indeed taking a decent time out. Economic data has turned down and sentiment indicators have taken a hit with tariffs coming in. Quite contrary to earlier general expectations, US bond yields have fallen meaningfully, and the dollar has weakened. Notably, the recent ‘risk off’ sentiment hasn’t helped the dollar as well. Apart from US specific reasons, an added meaningful recent development is the substantial fiscal pivot that seems underway in Germany to accommodate higher defense as well as general infrastructure spending. Indeed, the higher defense outlay may pertain to other European nations as well in light of recent geo-political developments.
Redistribution Underway
The simultaneous faltering of US growth drivers and potential emergence of new ones elsewhere points to an incremental redistribution of expected global growth. Should this expectation sustain, as seems very likely the case currently, then some redistribution of global capital should follow. This may sustain the recent easing of global financial conditions via the abatement in US dollar strength. In turn, this easing may finally percolate into EMs like India. Specifically, we will look for 3 effects to start to work again in our favor:
- The outflow of ‘growth capital’ (rise in outward FDI and aggressive FPI equity sales) can get arrested.
- The medium-term journey of rising FPI ownership of Indian government bond (less than 3% ownership of outstanding government bonds) can re-commence.
- As a result of the above, RBI can start recouping forex reserves with the consequent positive impact on rupee liquidity that will finally permit transmission of the monetary easing cycle. Indeed, an easing of global financial conditions may also allow greater degrees of freedom for RBI for policy easing.
While initial prognosis is good, one must nevertheless inject a word of caution before moving on: this still remains a highly uncertain world with major policy announcements almost par for the course virtually any given day. Thus, while reading the winds, one must also be cognisant of the risk that they change. It is also true, however, that truisms like these shouldn’t get in the way of whole-hearted analytical attempts to interpret uncertainty which, afterall, is one of the core asks from investing.
Specific Thoughts On Indian Bonds
The inertia in bond yields lately has been quite frustrating. A 25-bps repo rate cut (with more expected ahead), almost INR 1.4 lakh crores of OMOs (most of them in duration bonds), and a 50 bps fall in US bond yields, have failed to budge Indian bonds. Indeed, long duration yields have actually risen during this period. We have delved separately into dynamics at the long end recently (https://bandhanmutual.com/article/20748). Indeed, this looks to be the most attractively valued part of the yield curve currently and an obvious choice of investment for real money investors.
More generally, however, one hears anecdotally that banks have been happy to sell bonds under RBI OMOs without replacing most of them. Thus, RBI taking out duration from the market hasn’t led to much additional duration demand. Presumably this has been owing to near term tightness in resources which is expected to abate soon, especially if currency pressures are about to lessen. It is to be noted that, unlike equities, FPIs haven’t been meaningful sellers of bonds. Thus, any lethargy in performance is of our own making. However, if the changing global template described above holds, then ‘commercial’ demand for bonds will likely pick up ahead and liquidity environment may ease sustainably (also aided by RBI dividend and reversal in rise in currency in circulation from May). Combined with expected further rate cuts (we expect 2 more in the rest of this calendar year) and a rigorous fiscal stance, this sets up a favorable environment for duration in the year ahead. The starting valuations here are even more attractive now given recent underperformance, thereby further strengthening the outlook.
Source: RBI and Bandhan Internal Research
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