Suppose I ask you to lend me £1000, just for a month or so to see me through: I’m not looking to pay much interest because you’re not Wonga are you. But then if I need to buy a small house in Dundee on a ten-year mortgage, you’ll want more interest and you’d be right to ask for it too. Ten Year money is riskier for longer because nobody knows what tomorrow brings, perhaps I won’t even be there to pay you back. Naturally the borrower should pay more for a long-term loan and you’d think that would be a fundamental principle of financial markets… wouldn’t you?
Well it’s not.
Some markets behave very differently: in particular Ten Year Bond Markets where, in normal conditions (whatever that might be these days), long term instruments pay more interest because the lender has to be compensated for enhanced payment risk and guarded against credit flakiness (see above): but when conditions aren’t normal the principle flips and short term bonds have a higher yield than their long term cousins and that gives rise to a fascinating and important indicator.
Economists and fully paid up merchants of doom call it an the inverted bond yield and its not just a matter of academic interest: inverted yields generally (and almost inevitably) indicate that an economy is moving into recession: and if you think that’s all hocus pocus, fake news, smoke and mirrors take a look at the current difference (the spread) between Two and Five Year Bond yields in Venezuela which is a terrifying 9,248,972 base percentage points (“bps”). For ordinary human beings, that means there’s simply no market for long term debt in Venezuela: investors don’t think they’ll be paid back and no rate of interest will persuade them otherwise and let’s face it, with inflation having reached 1,698,488% in 2018 before the Maduro Government stopped producing statistics, they’re probably right.
It is therefore a matter of some concern that eleven countries worldwide currently have an inverted bond yield curve, not all by any means as striking as Venezuela: but striking nonetheless. The United States has a Five to Two year spread of minus 7.4bps and the UK is even worse at minus 8 bps.
Happily, India is not one of these eleven bellwether economies heading for the recessionary cliff: on the subcontinent the Five to Two year spread on bond yields is a healthy 8 bps (and that’s a positive 8 unlike the one in Westminster), and for Ten to Two year Bonds the spread is an even more attractive 75.3 bps. So no wonder then that Foreign Direct Investment into India is also running at an all time high at the moment, second only to China at $11,190 Million; betraying a level headed faith in India’s long-term prospects that is increasingly absent in other western economies (eleven of them in particular).
Manufacturing output is now slowing down in the United States and the UK, but it is picking up in India. After the re-election of the Modi Administration this year the Sensex and Nifty Indices reached new heights: with Nifty spiking sharply again as recently as 19 September.
Now those are fundamentals well worth paying attention to…
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Key economic indicators are difficult to find and even more difficult to assess accurately in any practical context: but the inverted bond yield has proved to be right time and time again as a precursor to recession and I think it would be rash to ignore. It is a core constituent of the fundamentals any market analyst will be looking for at the moment.
And to that extent I’m encouraged India is not only failing to follow in the footsteps of the eleven countries that currently have an inverted bond yield, but is positively buoyant in its latest report of Ten to Two Year spreads of as much as 75.3 bps.
The future is indeed unpredictable, but it pays to keep a close watch on the fundamentals.