If the US Treasury yields continue to rise, inflation continues to climb, and an improving economy pushes central banks to change policy stance, then it may lead to massive foreign fund outflows, forcing India’s share market into further correction.
As yields climb higher, investors tend to move away from equities to fixed assets such as bonds
A continued rise in the US Treasury yields might force India’s share market into a further correction. Of late, rising US Treasury yields have brought stock market bull run to a screeching halt, and have forced BSE Sensex and NSE Nifty 50 into sideways movement. Recently, yields climbed to breach January 2020 highs, after staying near zero for most of the last year, now forcing share markets into consolidation.
If yields continue to climb; an improving economy pushes central banks to change policy stance; and inflation continues rising, then it may result in massive foreign fund outflow from India’s share market. FPIs may pull money away to put it into fixed-income assets. Foreign Institutional Investors (FII) pulled money out of Dalal Street on 12 out of the 21 trading days in March. Net inflows for the month were in positive territory, but significantly less than the flows recorded in the last six months.
Why US yields are rising and how it makes government borrowing expensive: Improving economic outlook due to vaccine drive and recovery optimism comes with risks — bond yields soar and investors seek compensation for inflation risk. (Read here)
Growth outlook may set off yields concern
The improving growth outlook will outweigh the fear of yields as long as global liquidity continues to grow due to the accommodative stance of major central banks, analysts say. “If the growth outlook continues to improve for EMs like India and central banks remain accommodative, FII flows will continue despite normalising yields,” said Vinod Karki, Head – Strategic Research, ICICI Securities, told Financial Express Online. However, if yields do not consolidate and central banks signal quantitative tightening, foreign investors can be expected to pull money away from domestic markets, he added.
However, a sell-off like March 2020 is not expected. India’s high economic growth is expected to off-set the higher bond yield concerns. “Till the time currency is stable we don’t expect heavy FPI outflows from India. In the worst case we might see moderation to minor outflows from FPIs if Covid cases rise beyond proportion and earnings growth falters in future,” said Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities.
Rising yields: Good for bonds, bad for stocks
As yields climb higher, investors tend to move away from equities to fixed assets such as bonds. Morgan Stanley’s Head of Global Fixed Income Jim Caron had earlier warned that in a recovery scenario, there could be a rotation into lower-quality single-B- and triple-C-rated bonds. This is because as some investors become more comfortable taking additional risk, such bonds may start to outperform.
This is expected to impact the high-flying stocks that are now trading at a higher valuation and have surged significantly in the last few quarters. “Rising bond yields have an impact on equity valuations as it leads to compression of PE multiples. Dividend-paying stocks see lower compression as compared to high PE stocks,” said Naveen Kulkarni, Chief Investment Officer, Axis Securities. Stocks seem to be already bearing the brunt. The performance of MSCI Emerging Markets lagged that of developed markets in the last few weeks as yields rose, Rusmik Oza noted.