Global Bond Markets Are Shifting. What It Means for India

How India's Economy Works

Dr. Anoop Singh, former IMF Director, discusses the structural shifts occurring in global bond markets and the emergence of a 'new fiscal er

Key takeaways

• The US Treasury is increasing liquidity support buybacks in longer-dated bonds to improve market functioning during high debt issuance.
• A 'new era of fiscal dominance' is emerging where advanced economies face higher borrowing costs due to increased government spending and changing investor bases.
• Massive corporate demand for long-term capital, driven by AI investments, is contributing to higher market clearing prices for bonds.
• Central banks are becoming less frequent buyers of government bonds, shifting the burden to non-bank financial institutions.
• For India, fiscal credibility is 'indivisible from growth,' meaning markets must believe in debt sustainability to support economic expansion.

Main topics

• Global bond market shifts
• US Treasury interventions
• Fiscal dominance in advanced economies

Notable quotes

Fiscal credibility is indivisible from growth.

Conclusion

The episode highlights the critical need for governments to balance ne

Transcript preview

Speaker 1 (0:01) You're listening to How India's Economy Works, hosted by journalist and author Pooja Mehra. Speaker 2 (0:14) Dr. Anup Singh, thank you so much for coming to the show today. Speaker 3 (0:17) Thank you. Speaker 2 (0:18) I want to speak with you today about all that's going on in the Brobim bond markets. We read that the US Treasury is offering to buy back bonds and also that it's trying to jointly intervene in supporting the yen with Japan. What is going on and why is all this happening? Speaker 3 (0:35) Right. I'd say something unusual is happening and it's happening in the world's, what we thought were the world's safest financial markets. So as you said, the US, the Treasury has doubled the maximum size of its liquidity support buybacks in longer dated bonds. But this is not what we call QE. It's not that the government is trying to push the yields down. The Treasury is simply buying older, less liquid securities to improve the functioning of the market while it is simultaneously issuing enormous amounts of due debt. Japan is a bit different. Japan and the US took the unusual step of jointly supporting the yen. The U.S. intervention involved selling euros to buy in. But important to note that intervention weakened the yen, even as they raised the policy rate to 1.25%. So these are very different interventions. But they tell us, basically, this is point number one, authorities in advanced economies are having to pay much more. to the functioning of bond and currency markets than they've done in the last 20 years. Speaker 2 (1:59) So are you saying the two developments are unrelated, what's going on with the yen and what's going on with the US treasury bonds? They Speaker 3 (2:06) have similar contexts, but they are unrelated. So what's happening is this, my shorthand. We are seeing more government borrowing at the same time as we're seeing inflation being persistent. At the same time, we're seeing enormous demand and corporate financing needs for AI. We are seeing fewer institutions and central banks automatically buying bonds. And therefore, what we're seeing is a higher market clearing price for long-term capital. That's where the problem comes from. Speaker 2 (2:45) And will Fed's rate hike this week also in some way mitigate some of these concerns that markets have or the bad supply mismatch that there is in the bond markets? That's right. That's what's happening, right? Speaker 3 (2:57) Yes. Before I go into that, let me just make one point. Why is the U.S. Treasury market so important? It's because Treasury yields, of course, they are America's borrowing cost for itself. However... They are the main or principal benchmark for the global price of long-term capital and that affects every country globally. Now, you asked me, will the Fed hike help? Speaker 2 (3:25) That's right, yeah. Speaker 3 (3:26) Well, as you know, the Fed has raised its policy range by just 25 basis points. And it gave us a reason that inflation remains elevated, as it is, and the increase should support a speedier return to its 2 % goal. This, as you know, is quite the opposite outcome from what the U.S. president was hoping for. Now, will it help? Well, if investors become confident that the Fed's main role will be to prevent inflation from becoming entrenched, that will reduce the inflation risk premium that are now embedded in the long-term treasury yields. So it's simply that they've got to convince the markets that the Fed is a central bank and it is acting as such. Now, having said that, The Fed can only address, like any central bank, can only address part of the reason why yields have gone up. And as you know, years are not short-term, they're long-term. What is not under the Fed's control are the factors that are resulting in the problems we see in the bond market. The Fed has no control over large fiscal deficits, whether it's the Fed or RBI. It has no control over the extent of issuance of treasuries by the U.S. I haven't mentioned this, but the investor base has been changing. and the traditional buyers of government bonds, such as central banks, are buying it less. At the same time, we're seeing huge demand for AI investments, which want long-term capital. And so the issue is that the Fed can control only the overnight policy rate. It can influence long-term yield, but it depends on factors, as I just mentioned. that are not in the control of the Fed. Speaker 2 (5:29) So are you also suggesting that it isn't just a demand supply of bonds or various kinds of borrowings in bond markets, but also a question of newer risks or different risks? Yes, Speaker 3 (5:42) there are two major factors. One is the demand for long-term capital has increased from AI. And the second important reason is that the investor base has trained it over time. Central banks are buying bonds much less. And therefore, bonds have to be priced higher to induce other borrowers, many of whom now are now the non-bank financial institutions, to buy the bonds. Speaker 2 (6:08) And also, I think governments are borrowing more. So, overall borrowing requirements have risen, right? Speaker 3 (6:15) Yes. So, the fact is, we're in a new world. I call it a new world of fiscal dominance. But that is only a partial statement. We are seeing fiscal dominance because we're seeing fiscal dominance defined as government spending and government financing in ways we've not seen before in the advanced countries. At the same time, the investor base has changed. And so that's where we are. Now, will markets react? And how will the governments react? Speaker 3 (6:53) Main issue is that markets can change the price at which yields are bought. So that becomes a powerful constraint on governments. If you have high yields imposed by the so-called bond vitalantes, who are those who are buying the bonds, that raises interest spending by governments that leads to even higher deficits beyond their own spending. Therefore, that doubles back as higher refinancing requirements, that doubles back as a potentially still higher... yields. So we're seeing incredible developments in a new world. Speaker 2 (7:35) Okay, so I have many follow-up questions to what you've just said. But first of all, my listeners may not know what fiscal dominance means, if you could help us understand that. Speaker 3 (7:43) Oh, yes. Well, fiscal dominance is that, you know, in the old days, we thought governments were having crises of debt management in emerging markets. We've had Argentina very often having crises. We've had many countries in Asia having crises arising from government spending, arising from higher debt, and arising from inability to finance it. And also, most importantly, I'll come back to this, they were investing in areas and spending in areas that were not productive for the economy. So the issue is not just that you're spending more. The issue is equally what you're spending on. I'll come back to that point afterwards. What has changed is... In the new fiscal era we are in, it is the advanced countries that are now doing this. So the crises we may see coming are coming more from advanced countries. Now, if there is a crisis in advanced countries, emerging markets will, of course, be affected. But the trick now is that the move to fiscal dominance is