Posted by: Niyati on Thu, Oct 25th, 2018
Debt Market Indicators Every Investor Should Know
Economic activity significantly affects interest rates and thus, economists, traders, and investors always keep track of where the economy is heading. Where a slowing economy cuts down the demand for money and pushes down the interest rates, a growing economy generates new demand for borrowing and pushes up the interest rates.
The debt market and economic indicators go hand-in-hand, and there is a range of factors that drive the bond market. However, a handful of them is good enough to give you a hands-on understanding of what is generally happening in the economy.
By analyzing the trends of these indicators as an investor, you can gauge how the market is likely to react.
Four Important Debt Market Indicators for Investors
1. Yield Curve
The yield curve is the graph obtained by plotting yields to maturity of bonds from the same type of issuers against their respective maturities.
Due to the inflation risk associated with the tenure, typically, the bonds with higher duration have higher yields as compared to those with lower duration, resulting in a positive or normal yield curve. According to economists, a steep positive yield curve is an indication of strong economic growth with high future inflation.
A curve with an inverted or negative pattern occurs when short-term yields are higher than long-term yields. This indicates sluggish economic growth with lower inflation.
When there is nominal or no difference between long-term and short-term yields, the yield curve represents a flat pattern indicating that the investors are not sure about the future economic growth and inflation.
2. IIP (Index of Industrial Production)
IIP represents the production volume of a basket of industrial products during a given period as compared the base period. A period of sustained low IIP growth indicates slowing economic growth whereas high and growing IIP indicates rapid economic growth. The latter might lead to inflationary pressures and hence may push RBI to increase interest rates or tighten monetary policy.
3. GDP (Gross Domestic Product)
GDP represents the growth-pace of the domestic economy and is a crucial macroeconomic indicator. GDP growth at or below the expected value or trend rate indicates poor output and slowing demand. This, in turn, may motivate RBI to decrease interest rates leading to an increase in demand for bonds, pushing their prices higher.
On the other hand, strong GDP with rising inflation can result in a drop in bonds value due to increased fear that RBI may increase short-term interest rates.
Inflation or expectation of inflation can drive up the bond yields and vice-versa. Increased food prices of kharif crops and consistently high oil prices are primarily responsible for higher inflation in 2018. The RBI could also be compelled to raise repo rates. These factors are triggering the increase in bond yields.
Besides these debt market indicators, one has also to pay close attention to international factors as they can significantly impact bond yields. One example is the tightening financial condition in the global market caused by shrinking labor market and higher fiscal deficit leading to faster rate hikes in the US which can impact the Indian bond market.
Knowing debt indicators is important but can also be intimidating for new investors and professionals. Center of Investment Education & Learning (CIEL) focuses on competency building for the investment and financial services sector and offers online debt market course with interactive self-learning modules. With courses developed by subject matter experts who have years of experience, you can build strong foundations and grasp vital concepts like short-term rates, credit spreads, and economic indicators with easy-to-understand examples.