On October 23, 2023, the yield on US 10-year government bonds surpassed the 5% mark during the trading session, reaching its highest level since 2007. Historically, the interest rate spread between 10-year Indian government bonds and US government bonds has typically ranged between 400 to 600 basis points. However, recently, this spread hit a ten-year low of approximately 250 basis points. This raises the question of whether US government bonds have become an attractive investment option. Let’s delve into the considerations.
Key Factors for Investing in US Government Bonds: Several favorable factors support investing in US government bonds:
- Attractive Yields: Presently, US government securities across various maturities, including 1, 2, 3, 5, 7, and 10-year bonds, offer yields in the range of 4.5% to 5.5%. These yields are compelling when compared to historical yields on these securities. The current rates have not been seen since 2007-08, a span of 15 years. Additionally, these elevated yields may not persist for an extended period. Hence, considering investment in US government bonds to capture the current high yields could be prudent.
- Potential for Capital Appreciation: The current high yields on US government bonds are a result of the US Federal Reserve’s efforts to combat elevated inflation. However, over the past year, US inflation has significantly receded from its peak of 9.1% to 3.70% in September 2023. Concerns also exist regarding the possibility of the current high interest rates substantially slowing down the US economy or even triggering a recession. When the US inflation rate falls to the US Fed’s target of 2% or lower, or if the US economy experiences a significant slowdown or recession, the US Fed is likely to reduce interest rates.
It’s essential to note the inverse relationship between interest rates and bond prices. Bond prices rise as interest rates fall and vice versa. Consequently, when the US Fed cuts interest rates, bond prices are expected to rally, providing an opportunity for capital gains. Bonds with longer maturities (e.g., 5, 7, 10 years) are more sensitive to interest rate changes, offering a higher potential for capital gains.
According to current projections by analysts, the US Fed is expected to lower interest rates in the second half of 2024. Until that occurs, investors can benefit from the prevailing high yields.
- Depreciation of the Indian Rupee: Investing in US Dollars can also yield gains from the depreciation of the Indian Rupee against the US Dollar. Over the past decade, the Indian Rupee has depreciated against the US Dollar at an average rate of approximately 3%. This exchange rate trend contributes to overall gains from US government bond investments.
- Geographical Diversification with Strong Credit Rating: Investing in US government bonds offers geographical diversification, enhancing your investment portfolio’s resilience. Diversifying across various levels, including country-wise, asset class, and within each asset class, is prudent.
Moreover, US government bonds boast an exceptional credit rating. The US government has maintained an impeccable record of meeting its debt obligations without defaults. These bonds are highly liquid, facilitating easy buying and selling due to the continuous presence of buyers and sellers.
In summary, investing in US government bonds presents an attractive option given the current high yields, potential for capital appreciation, currency exchange benefits, and geographical diversification, all supported by a strong credit rating.
