India facing tough task of reining in inflation

Even as US Treasury market is going through recession warning, where the 10-year note's yield fell below the three-month's bill, it is time for India to read the writing on the wall. Global investors anticipate dire economic consequences of the Federal Reserve's campaign against inflation.

Furthermore, the 10-year yield dipped as much as 0.08 per cent below the three-month level in US trading on Wednesday last, after brief and smaller inversions on Tuesday and in early August. The day's lows for both yields were reached shortly after Bank of Canada raised its policy rate by half a percentage point, less than expected.

Inversions of this segment of the Treasury curve typically occur late in Fed tightening cycles as three-month bills track the policy rate while longer-term borrowing costs reflect expectations for economic growth and inflation. While other widely-watched yield curve segments such as the two- to 10-year and five- to 30-year notes have been deeply inverted for much of this year, the Fed follows this one more closely.

Another three-quarter-point hike from the current 3 per cent to 3.25 per cent range is still expected for this week's policy meeting, based on swap contracts referencing the event, but traders are divided on whether the subsequent move will be 50 or 75 basis points in December.

As the US central bank tries to use rate hikes to curb inflationary pressures, the risk is that economic activity responds more quickly, and that the Fed won't lower rates until there's progress on inflation.

Long-dated Treasuries rallied sharply on Tuesday after gauges of home prices and consumer confidence declined more than expected. US 30-year fixed mortgage rates topped 7 per cent last week for the first time in two decades, an example of how Fed rate hikes are percolating down.

Inversions of the three-month to 10-year yield curve have heralded past recessions. The curve inverted as much as 0.28 per cent in March 2020 and became deeply negative in 2019, 2007 and 2000, all at the end of Fed tightening cycles.

While the prospect of more Fed hikes maintains upward pressure on bill yields, the 10-year is in retreat from multiyear highs. It peaked at 4.34 per cent last week, up from 1.5 per cent in January. Buying now may prove rewarding as economic weakness broadens, possibly leading to rate cuts by late 2023 or 2024.

Recent surveys have revealed investors are adding more interest-rate risk to their portfolios to benefit from declining long-term yields. The SMRA portfolio survey was net long for the first time since 2021, while JPMorgan Chase & Co's Treasury client survey was most bullish in two years. Hence, the eyes are now set on MPC meet on November 03.

It has to be seen how is MPC able to tackle a host of crises the country is currently faced with in forms like staggering inflation and rising interest rates.