On Wednesday, the yield of the 365-day treasury bill (T-bill) in India rose above the benchmark 10-year bond, which indicates a yield curve inversion. The Reserve Bank of India (RBI) sold 364-day notes at a yield of 7.48%, the highest since October 2018. In contrast, the 10-year benchmark 7.26% 2032 bond yield reached a high of 7.4728% and ended at 7.4547%, according to Reuters.
Over the last six weeks, the 364-day T-bill yield has risen by 58 basis points amid high uncertainty about interest rate hikes and the worsening liquidity in the banking system.
Treasury Bills are short-term debt instruments issued by the Centre, with three tenors available: 91 days, 182 days, and 364 days. The government issues them when it requires money for a short period. Only the central government issues these bills, and their interest rates are determined by market forces.
In India, T-bills were first issued in 1917 and are issued through auctions conducted by the RBI at regular intervals. Financial institutions, individuals, trusts, and institutions can purchase T-bills, but they are usually held by financial institutions.
What is yield curve inversion?
The yield curve indicates the returns on government securities over varying tenures. Typically, the curve slopes upwards, and the returns increase with a longer maturity period.
However, when the returns on short-term securities exceed those on long-term securities, it is known as yield curve inversion. This implies that the market is becoming more pessimistic about the economic outlook in the near future.
The term “inverted yield curve” was coined by Campbell Harvey, a Canadian economist, in his 1986 doctoral thesis at Duke University. To construct the yield curve, treasury bill yields are compared to the benchmark 10-year bonds.
According to a blog by the World Economic Forum (WEF), inverted yield curves have accurately predicted almost every recession. “The worrying trend is that an inverted yield curve in key government securities such as US Treasuries can often foreshadow a recession. For every recession since 1960, an inverted yield curve took place roughly a year before, with just one exception in the mid-1960s,” it said.
According to Investopedia, inverted yield curves are a critical component of economic cycles, preceding every recession since 1956. The yield curve inversion usually occurs 7 to 24 months before a recession.
Experts suggest that the yield curve inversion may signal an impending recession in developing countries such as India. However, VK Vijayakumar, the chief investment strategist at Geojit Financial Services, believes that the correlation between yield curve inversion and recession is typically only found in developed countries. The inversion in India occurred due to higher-than-expected cut-offs on treasury bills sales, which in turn resulted from a deficit in liquidity in the banking system. This declining liquidity trend and the inversion of the yield curve are likely to persist for some time. However, it is not expected to affect India’s GDP growth in FY24.
When did the yield curve invert last?
Prior to Wednesday, the 10-year and 30-year bond yields had converged to the same level on February 22, both finishing at 7.39 percent. On February 8, the yields on US two-year bonds surpassed those on 10-year bonds, with the difference between them widening to an unprecedented 86 basis points.
The recent inversion of the yield curve in India could indicate challenging economic circumstances in the near future.
