US yields are America's headache, but DXY may be world's concern: Kotak Equities

Economic Times

2 days ago

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Surging US bond yields signal economic fragility, elevated risk perception
US faces broader consequences from a weakening dollar
Dollar slide could reshape global investment and capital flow trends
Indian monetary policy trajectory may not be influenced by high US yields
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The recent surge in US bond yields and a weakening US dollar index DXY ) have brought to light the diverging consequences of these two critical macro indicators. While rising bond yields are often seen as a reflection of monetary policy expectations, domestic brokerage firm Kotak Institutional Equities argues that in this case, they are more symptomatic of the United States' weakening fiscal and macroeconomic fundamentals.According to the brokerage firm's report, the sharp uptick in yields is being driven not by growth optimism but by concerns over an expanding fiscal deficit , heightened policy uncertainty, and a growing risk premium. These developments, Kotak notes, could remain largely a domestic concern, impacting the US's debt servicing costs and future borrowing outlook, without necessarily spilling over into other economies.However, the picture is quite different when it comes to the US dollar. A weakening DXY, Kotak contends, carries far more global implications. As the cornerstone of international trade and finance, fluctuations in the dollar's strength ripple through currency markets, capital flows, and sovereign reserve allocations.The report highlights that a sustained decline in the DXY could prompt non-US investors to reassess their holdings of US assets, reorient global capital movements, and potentially trigger asset repricing across regions.In effect, while 'US yields are US's problem,' the DXY is 'everybody's problem,' given its influence on investor behavior, financial stability, and the broader structure of global capital markets According to Kotak, the recent sharp rise in US bond yields primarily reflects concerns around deteriorating US macro fundamentals. The report attributes the movement to market pricing in '(a) continued weakness in US macro (higher fiscal deficit) and (b) greater macroeconomic and policy uncertainty,' which in turn has led to increased risk premiums demanded by investors.The brokerage notes that elevated bond yields 'for an extended period of time will also affect the US's fiscal and debt position with new bonds likely at higher rates versus old bonds,' exacerbating the fiscal burden. Kotak Equities warns that a decline in the US dollar index (DXY) could have far-reaching consequences for the US itself.'The true value of the USD may have been masked by its haven status,' the report said, despite the 'steady deterioration of US economic fundamentals over the past decade.'The brokerage pointed to the past funding of the US's excess consumption by the excess savings of Asia and Europe, which had led to rising capital flows into the US and growing ownership of US assets by non-US entities. However, further weakening of the DXY may 'change the status quo and require a shift to (1) lower US consumption and/or higher US production (higher US savings), (2) higher consumption (lower savings) elsewhere and (3) higher yields (risk premium) for US assets.'While higher US bond yields may remain a domestic concern, the weakening dollar could influence asset allocation strategies globally.Kotak stated, 'A weakening DXY may have several long-term implications for countries and global capital markets.'The report highlighted that 'non-US holders of US assets may review their ownership of US assets on both stock and flow basis versus their earlier position of unconcerned ownership of US assets given low currency concerns.'With everything said, the report was cautious about whether this shift would directly benefit emerging markets such as India. It flagged the possibility of a 'reset' in global capital flows , though the direction remains uncertain.According to the report, the rise in US yields is unlikely to significantly impact the Reserve Bank of India's monetary policy. Indian bond yields continue to offer a healthy premium over US yields, and India's macroeconomic fundamentals have improved compared to the US over time.Key factors such as (1) a likely low current account deficit and a healthy balance of payments, (2) manageable inflation levels, and (3) a 'fair' INR valuation based on the REER offer a cushion against external shocks, allowing the RBI to maintain its focus on domestic growth.However, the domestic brokerage firm noted Key risks from such a reset could include: (1) higher yields (lower bond and equity prices) in the US for non-US entities to stay invested in the US, (2) greater investment in home markets although this runs the risk of asset bubbles in those countries and (3) change in consumption-saving behavior of 'saver' countries.': Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)