The yield on US 10-year bonds is almost a 16-year high. How may this affect the Indian stock market?

 The yield on US 10-year bonds is almost a 16-year high. How may this affect the Indian stock market?

The likelihood of another rate rise has driven up US 10-year Treasury rates to a level that is over 16 years high. Jerome Powell, the chairman of the Federal Reserve, said on Thursday that the US economy's resilience and a tight labor market may need more interest rate increases to bring inflation down to the objective of 2%.

Jerome Powell, the head of the Federal Reserve, said on October 19 that the US inflation rate is still too high and that it would probably take a slower-growing job market and economy to get it down to the Fed's goal inflation rate of 2%.

US bond rates have increased noticeably and are almost at their highest points in 16 years. The uncertainty surrounding US interest rates in the future is the main cause of this. Everyone believed there would only be one more rate increase a few weeks ago. Experts note out that Fed Chairman Powell shocked everyone on Thursday by speculating that there may be further rate increases in the future owing to the robust economy and competitive labor market.

Experts noted that this opinion from the Chief increased market trepidation and sent US 10-year yields close to the 5% level just when markets were considering that rates were high enough. The last time these levels were seen was in 2007.

US 10-year bond rates decreased by more than 1% on Friday and remained close to 4.94%.

The rise in US bond yields: why?

The interest rates set by the Federal Reserve have an impact on bond yields. According to experts, the recent trend of increased interest rates is the source of the rising bond yields. This may also be seen as a covert indication of growing inflation and a likely downturn in the economy, both of which raise borrowing costs.

In addition, rising bond supply, macroeconomic unpredictability, and geopolitical unrest have all pushed higher bond rates.

Increased supply in recent quarters, higher real yields (which rose as markets downplayed recession risks), inflation expectations (which are increasing down amid negative inflation surprises in current months), and Fed repricing and the soft obtaining narrative leading to higher term premia have all contributed to the recent spike in nominal long-end yields, according to Madhavi Arora, lead economist at Emkay Global Financial Services.

How can the Indian stock market be affected by rising US bond yields?

Foreign portfolio investors (FPIs) often sell their holdings in developing market stocks and shift their assets to US bonds when US bond rates increase. The assumption that bonds are less risky than stocks and have more appealing return potential is what is causing this move.

Higher bond rates, according to Kaushik Dani, Fund Manager - PMS, Abans Investment Managers, are detrimental to equities.

He made the argument that higher equities markets become less appealing due to high bond rates, and that risk-averse investors are the first to shift the asset allocation. Foreign investors move their money out of developing countries like India as a result of the risk-off approach. This is due to the fact that around that time, US Treasury offered FPIs superior dollar returns than stocks.

Dani said that local institutions with mixed aims, as well as international investors, often switch money from equities to debt. Overall, selling pressure on the stock market would be maintained by withdrawals from stocks, particularly when valuations are trading above those of other developing countries, Dani noted.

The co-founder of Equitree, Pawan Bharaddia, noted that higher bond yields typically result in a capital flight from equity to bond markets, which is what has been happening over the past two years. FIIs have been net sellers of bonds worth nearly 2,78,000 crore in calendar year 2022 and 37,000 crore since the start of calendar year 2023, respectively.

Since stock valuation and bond rates have an inverse relationship, according to Bharaddi, value investing has been more popular in recent years, which has rekindled interest in small and mid-cap firms.

"We believe that as a greater rate of interest is likely to continue so will the genre of investing for value continue attracting a greater number of investors in the small and mid-cap space," Bharaddi said.

Any prospects for a rate drop have been delayed until late 2024, according to Manish Chowdhury, Head of Research at StoxBox, since the Fed is only focusing on the current target inflation rate of 2%. This might put pressure on stocks.

"With risk aversion ruling the day, high-yielding assets, especially Indian shares, may see some damage. The overall balanced nature of the economy, which is further reinforced by increased corporate profitability and growing domestic market involvement, is the savior for our markets, Chowdhury added.

According to Madhavi Arora of Emkay, rising real rates and the cost of capital pose a growing danger to still-rich market values, and profit projections for the next year look unduly optimistic.

This time, the repercussions of high rates take longer to take hold, but we think the worst is yet to come. Future equity picture calls for caution, according to Arora.