What is causing the global bond sell-off?

When bond yields surge globally, some observers blame irresponsible politicians. In the United States, President Donald Trump is overseeing massive deficits and attempting to pressure the Federal Reserve into providing easy credit. Other governments are similarly unconcerned about borrowing and lack respect for central bank independence.

This suggests higher yields due to investor alarm about possible future inflation. However, the treasury secretary of the United States, Scott Bessent, argues that bond markets are reacting to the promise of faster long-term economic growth. This growth, driven by the artificial-intelligence revolution, will increase productivity in the future but requires substantial capital investment in the present to build data centers and power generation infrastructure.

The public sector is competing with the private sector for funds. To test these theories, consider India. The yield on ten-year Indian government securities (Gsecs) has risen by 0.37 percentage points to 7% this year, while yields on ten-year U.S. Treasuries have increased by 0.67 percentage points. Despite this spread remaining near historical lows, the effect of the rising yields is less pronounced in India compared to its older counterparts.

This indicates that the bond yield spike may be affecting India to a lesser extent than developed nations. Growth in India is impressive, with the economy expanding by 7.8% year on year in the second quarter, driven by a 12% increase in private investment. The Centre for Monitoring the Indian Economy estimates that new projects, particularly data centers and nuclear power plants, have grown by 27%.

If the government and public sector are competing for funds with a capital-intensive private sector, Gsecs should be impacted more significantly. Additionally, India's fiscal deficit, which is near pre-pandemic levels, and the government's efforts to raise revenue from privatisations suggest that inflation risk may not be a significant concern.

Moreover, captive investors in India, such as life insurers, banks, and pension funds, have limited options for reallocating capital, limiting the ability of foreign investors to influence bond yields. As a result, India's bond market may not be the best indicator of bond yield trends worldwide. Nevertheless, India's experience highlights the importance of sound public finances and central bank independence in addressing inflation and preventing excessive bond yield increases.