Globally, there has been a noticeable shift away from US dollar assets. “From a longer-term perspective, we have been seeing a reduction in dollar assets. China, for instance, has been reducing its US Treasury holdings, its allocation in FX for some time away from US dollars,” Kotecha observed.
In contrast, India appears better positioned amid these global shifts. Kotecha noted that India’s relative insulation stems from two key factors: it is a closed economy, less dependent on trade, and it has made significant fiscal progress. “India is in a better position — the consolidation that is taking place towards the deficit of around 4.4% of gross domestic product (GDP). Borrowing requirements are fairly well constrained. Inflation has come off fairly rapidly and the currency is stable, if not firmer,” he said.
These fundamentals have supported Indian bond markets, Kotecha added, with performance increasingly justified by underlying economic strength — a contrast to the situation in the US.
Suyash Choudhary, Head of Fixed Income at Bandhan Mutual Fund, highlighted that one of the key trends over the past several years has been the so-called “US exceptionalism” trade, which attracted significant global capital into the US.
However, what stands out in the current phase is the unusual combination of a global risk-off sentiment occurring alongside a weakening US dollar, which has fallen roughly 8–10% since mid-January, depending on the index tracked. Typically, during a risk-off phase, the dollar would strengthen, making this development quite unprecedented.
These are edited excerpts of the interview.
Q: If you can take us through and explain the rise and rise in the US yields. Why doesn’t anyone want to buy US bonds?
Kotecha: The reality is that there has been a scare in US bond markets. Just a couple of weeks back, there was a lot of discussion about foreign selling of US bonds. There was also concern about these leveraged positions that have been built up. The basis trade was very popular for US Treasuries as well as swap spread pressure,s and at the same time,e an increase in term premium as markets started worrying about inflation risk going forward.
So, there are a number of factors that were weighing on US Treasuries, especially towards the longer end of the curve. We have seen a little bit more of a consolidation and a bit more stability since then, and some of those market pressures have eased. But nonetheless, as you mentioned, there was a massive difference between the performance of US Treasuries and what is happening with global bond markets, in particular India and elsewhere in Asia.
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But the treasury selling may not be over at this point, or at least the treasury pressures may not be over. But we think there are some opportunities,s and our US rate strategy team has been long five-year US treasuries with the view that some of these pressures are overdone at this point in time.
Q: Would you want to add to this? Why do you see US yields rising? And as Mittul pointed out, everything other than the US, the yields seem to be falling. German bonds are also falling, but how do you explain the fall in Indian yields?
Choudhary: One of the notable aspects of the last many years has been the so-called US exceptionalism trade that has drawn a lot of global capital. And what is remarkable in this phase is you are seeing a global risk-off, and simultaneously with that, you are seeing the dollar weaken by roughly 8-10%, depending upon which index you trac,k since the middle of January. And that is the unprecedented thing in this move because typically in a risk-off environment, you would see the dollar rising.
So it is probably two things happening at the same time, which is the risk-off getting let out by some unwind of the US exceptionalism trade that is leading to global portfolio managers diversifying away from the US to some extent for emerging markets like us making the best of a reasonably bad situation, it’s good news because what it allows is for us to run monetary policy relatively more independently. So had the dollar been strengthening into this, even if the Reserve Bank of India (RBI) wanted to ease policy, it would have been difficult for them to be able to transmit the rate cuts that they would be doing.
However, in this environment, the RBI is able to transmit the rate cut because they don’t have pressure on the currency side. That said, the RBI has a better trade-off on inflation versus growth as the governor very clearly clarified that the tariff world will lead to weaker growth, and therefore, we have more leeway to act on that.
So it is the combination of all these factors basically playing that you have more policy room to ease because currency is not under pressure, and the growth-inflation trade-off is relatively clearer for yo,u as a result of which bond yields are responding to this environment.
Q: In India, growth and inflation are under pressure, growth under pressure because of global headwinds, inflation under pressure because of an expected Chinese-led disinflation. But usually, we say that the difference between the US yields and the Indian yields should not be too much. At the moment, the difference between the two yields is declining. So wouldn’t that be negative for the RBI to cut?
Choudhary: The argument is not as powerful in the current scenario because you would also remember that post-pandemic, the US is on a different fiscal trajectory. So the first round of yield narrowing happened because the US is now on a 6.5% fiscal deficit,t and India has consolidated. Many other EMs have also consolidated. So that accounted for the first round of narrowing of the yield differential.
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The second round is what we just discussed, which is some bit of the US exceptionalism playing out and therefore the need to diversify away a bit from dollar assets. And our sense is that you can live with narrow real differentials given the current trade that is playing globally, which is the need to move away into well-run other geographies which have relatively deep capital markets.
Q: I wanted a slightly longer-term view from you. What the US is basically asking every other country is that you run a deficit with me, don’t run a surplus with me. Now, if I don’t run a surplus with the US, I don’t get dollars from them, and therefore, I will not buy US bonds. Isn’t the Trump administration killing any appetite for US bonds if they ask everyone to run a deficit with them? So, is there a structural distaste for US Treasuries?
Kotecha: There is a structural issue here because as you say, if the reality is if the US suddenly doesn’t have the large deficits with other countries, then other countries will not be funding the current account deficits, not be providing dollars to the US, and not be buying US Treasuries in the same quantities that they have been.
And so this has been a concern. This has been something that’s weighed on US Treasury markets. And the fiscal premium is also rising because clearly, when you look at the bills that are going through the Senate and the House, there is going to be a large increase in the fiscal deficit in the US.
It is not only about making Trump’s tax cuts permanent, but there are other measures going through. So you have got so many headwinds now that are starting to weigh. And as you said, the bigger one here is a longer-term structural one — will there be enough dollars going back into the US to buy US assets if the US succeeds? And it is a big if — if the US succeeds in narrowing its deficit with the rest of the world, that could be a longer-term structural issue.
And look, for the rest of the world, what we are starting — or not just starting, but from a longer-term perspective — we have been seeing a reduction in dollar assets. China, for instance, has been reducing its US Treasury holdings, its allocation in FX for some time, away from US dollars.
And India is somewhat isolated from a lot of this because (1) it is a closed economy, it is less trade-driven. And (2), fiscally, India is in a better position – the consolidation that is taking place towards the deficit of around 4.4% of gross domestic product (GDP). Borrowing requirements are fairly well constrained. Inflation has come off fairly rapidly, and the currency is stable, if not firmer. And so all of these do bode well for further gains in Indian bonds.
And what we have been seeing is that outperformance is justified by fundamentals in India, whereas in the US, that hasn’t been the case of late.
Q: What is your Indian bond range or forecast by June or December?
Kotecha: Our 10-year IGB forecast was 6.25% by the end of this year. But look, the move in bond yields in India has been more rapid than anticipated. So it is possible that we could get there even earlier, but we have our forecast of 6.25%. And so the trend we still think is going to be for lower yields in this environment.
India’s growth is still holding up better than most countries, but clearly it may be taking a hit from global trade weakness and global recession that we are anticipating. So that could also be a factor supporting India’s bond markets.
Q: Your bond yield forecast for June and December? 6.25% that Mitul Kotecha says is only 7-8 basis points away.
Choudhary: Things are happening fast, and recently we have taken down our terminal repo rate forecast to 5.5%.
There is a likelihood that if the global growth shock turns out to be bigger, then this could be even slightly lower. Also, one of the very important factors on the table is RBI is focused on the transmission of rate cuts that it is undertaking. So by our calculation, by the end of April, the RBI would have conducted almost ₹4 trillion worth of OMO purchases.
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Another ₹2.2 trillion of FX swaps have been done. So, all combined, significant liquidity measures have been undertaken. Not to mention that the ₹4 trillion of OMOs have taken out that much duration from the market, thereby creating more duration demand.
So our sense is, you could easily see the early success. That is probably a good place to work for the foreseeable future. It all depends upon whether the dollar finds a floor soon enough. Our sense also remains that eventually the Fed will have to sway in favour of curtailing the rise in unemployment because there may be slightly more permanency to that rather than the one-time shock to inflation. That is an evolving scenario.
So if the Fed were to swing into action, then by definition, Indian bonds will also have that much more space to fall eventually. Although, like we discussed, on their own, they are doing just about fine till now.
Q: I need a dollar range as well, if you can, a dollar-rupee range. But more importantly, a DXY — does it go much below the current 98.5?
Kotecha: More broadly, we have just revised our euro-dollar forecast and we now have mark-to-market, our views on the dollar have been somewhat constructive and clearly they have been under a lot of pressure. And now we do see potentially at least in the short-term euro-dollar to edge up to sort of 1.17.
And a medium-term view now, which is reflective of our sort of augmented PPP fair value measures, is that euro-dollar settles around 1.15 in the next several months. So on that basis, look, we may have seen almost the full bulk of dollar weakness, but you can’t rule out a little bit more short-term weakness.
What we would say is that positioning is very negative. Sentiment is also very stretched negatively. One thing that is concerning us in terms of the hit to the dollar is the pressure on Powell here and what impact that has on US policy credibility, certainly if he’s pressured into lowering rates. So again, that is weighing on the dollar as well. So it is hard to rule out further short-term pressure. And again, as I said, we have now shifted our medium-term view to more sort of consolidation around this 1.15 euro-dollar.
Q: You were the first person to say 1.15 euro-dollar when euro-dollar was at 1.00 when we last met. But very quickly, just in case Powell is made to leave — I don’t think that’s anybody’s base case because the law is very clear — he stays till May 26. But, if something were to happen, what’s the pell-mell in the market?
Kotecha: Look, it is a very low probability event — but if, for some reason, he is forced to step down ahead of the end of his term, markets would react very negatively to this and it would send, in our view, the dollar sharply lower. It would probably send US yields sharply higher. Look, the front-end may move lower because markets may expect expectations of rate cuts, but certainly you would end up with a sharp move on the longer end of the curve reminiscent of what we just saw a couple of weeks back.
So, markets certainly would not react well to a premature termination of Fed Chair Powell’s term.
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