The US Federal Reserve has been hawkish for nearly 18 months in its relentless fight against inflation. It has increased interest rates from near zero levels to 5.25-5.5 per cent by hiking rates 11 times over the past year or so. Barring a few odd spikes, inflation has cooled off steadily from 9.1 per cent in July 2022 to 3.7 per cent in October 2023.

But the labour market continues to be tight with very low employment and the economy is still in growth mode (though at a slow pace of a little over 2 per cent). The Federal Reserve want these metrics to slow down reasonably so that inflation is fully contained. Though it paused rate hikes, it still maintains a hawkish outlook.

As a result, yields of many tenors of US treasury securities have risen sharply over the past few quarters and more so in recent months as geopolitical developments add to concerns.

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Though there is a chance of another rate hike in the coming quarters, the general expectation is that yields are close to the peak as the interest rate cycle may be close to the top. The difference in yields of Indian G-secs and those of their US counterparts for similar tenors have narrowed considerably.

Do these high yields present attractive opportunities for investors?

Aditya Birla SL Mutual Fund has rolled out two fund of funds – investing in units of US Treasury 1-3 year and US Treasury 3-10 year bond ETFs.

Here’s more on the yields from US Treasuries, the potential opportunities for you to take an informed call.

Yields surge to attractive levels

Interest rates and yields tend to move up in tandem. And therefore, bond price movements are inversely related to yields and interest rates. As mentioned earlier, US Treasury yields are at multi-decadal highs. Buying bonds close to the interest rate peak will mean that when yields cool off, there is scope for bond price appreciation.

Since 2021, US 10-year treasury bond yields rose steadily and are currently at 4.89 per cent (October 18), up from 1.5 per cent levels in October 2021.

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The one-year treasury yield is at 5.47 per cent (October 18) per cent from 0.72 per cent in February 2022. Even 2-year and 5-year treasuries trade at 5.2 per cent and 4.91 per cent, respectively. These were levels last seen in 2005-07.

When long-term yields are lower than short-term figures, we have yield inversion. So, investors have bought more of long-term securities, while selling short-term ones, causing bond prices to fall and yields to rise. This yield inversion also indicates investors fear of an economic slowdown or recession. But the US has avoided recession so far.

The expectation is that inflation will go down further, employment will weaken further and the economy will get to an anaemic growth or stagnate. If these events play out, the Federal Reserve may ease rates sometime later in 2024.

For perspective, India’s 364-day treasury bills trade at 7.14 per cent. The spread (difference in yields) between US and Indian treasury bills was 390 basis points in February 2022. This has come down to 166 basis points. Even the 10-year spread is down to just 247 basis points, a decadal low.

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Given the current high yields, there is an opportunity presented to lock in at these levels. Of course, the expense ratio will decide the final yield that an investor gets. Given that the fund of fund will invest in ETFs, expenses are not likely to be high. The underlying ETFs usually carry an expense ratio of 3-6 basis points. The FoF will add a bit more to these costs.

It is important for investors to note that these yields are available at this point in time during the NFO. A few months or a year down the line, the yields would change (could be lower or higher) depending on the interest rate scenario, inflation outlook, central bank actions and so on. Investors wishing to take exposure later on must take this into account.

Rupee-dollar dynamics

Rupee’s depreciation against the dollar is an important factor for investors. From 2003 to 2007, the rupee appreciated against the dollar, before falling in 2008. It staged a comeback against the dollar between 2009 and 2011. But from 2011, barring short periods of gains, the rupee (from 44-45 levels) has generally been on a depreciation path against the dollar.

Currency movements in the future hinge on economic growth, inflation, interest rates, geopolitical factors and the US dollar’s position as the mainstay in global trade – many countries are settling trade in local currencies. But if a secular depreciation (non-linear) of 3-4 per cent annually, that may add to returns for Indian investors.

What should investors do?

Given that both Fund of Funds track US treasuries, there is no credit risk. There may be duration or interest rate risk though if investments are not aligned to the right timeframes. The Aditya Birla SL US Treasury 1-3 Year Bond ETFs Fund of Funds may be suitable for those with a short to medium term horizon, while the 3-10 year variant may be advisable for those with a long-term horizon.

As a proxy to dollar exposure, small investments can be considered for goals such as child’s US education over the long term or for any dollar-related expense due in the short to medium term.

Investments in the US provide diversification to a portfolio. Investing via US equities may better serve investors. But the recent taxation and tax collection at source moves are negatives, though not enough to avoid US equities.

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Given the safety of the underlying bonds, the current high yield and the kicker via rupee depreciation, a small lump-sum may be considered by investors for diversification outside their core domestic debt portfolio.

However, returns may not be spectacular and are likely to be lower than those of Indian T-bills.

The NFO is open now and it closes on October 30.