Typically, bond yields and equity markets work in inverse. Rise in bond yields make it an attractive asset class, as investors tend to sell equities and pump in more money into bonds. Image: Reuters/Shailesh Andrade/File Photo
Over-heated bond yields in the US and ever-increasing crude oil prices broke investors’ confidence on Indian markets. In the sharpest single-day decline since August, India stock markets lost over 1 percent on Wednesday as jittery investors rushed to take money off the table with the 10-year treasury yields in the US jumping to nearly 16-year highs or highest since 2007.
Typically, bond yields and equity markets work in inverse. Rise in bond yields make it an attractive asset class, as investors tend to sell equities and pump in more money into bonds.
During the day, the BSE Sensex tanked 868.70 points before closing at 66,800.84, losing 796 points or 1.18 percent. The 50-share index Nifty also declined 313.5 points, closing for trade at 19,901.40, down 231.90 or 1.15 percent.
Milind Muchhala, executive director, Julius Baer India, feels there are potential sources of intermittent volatility, such as the US Federal Reserve’s actions, rising commodity prices (especially crude oil), uncertain monsoon impact on crop production, upcoming state elections, and soft rural consumer demand.
“Foreign institutional investors (FIIs) flows, while previously robust, have started tapering off, possibly due to India's outperformance among emerging markets and potential US Fed rate hikes. It's important to remain slightly conservative as corrections can be swift. Despite intermittent corrections, the overall positive outlook for Indian markets remains, driven by economic growth, strong corporate earnings, robust expected inflows, and valuations in line with historical averages. Interim corrections should be viewed as opportunities to increase equity exposure for long-term investors,” he adds.
Crude prices have been increasing rapidly with brent hitting over $90 per barrel, raising caution on ballooning inflation worldwide as the US Federal Reserve prepares to release its monetary policy review tonight. The global central bank is widely expected to keep interest rates on hold, but market investors will watch out for its economic projections while high crude price may still mean a rate hike this year. In June, the US Fed had paused hiking rates.
Investors in contracts tied to the federal funds rate consider it a near certainty the US central bank will leave the benchmark federal funds rate at the current range of between 5.25 percent and 5.5 percent, a step consistent with the Fed's shift to a slower and more considered pace of rate increases, according to Reuters. From March 2022 through May 2023, the Fed raised rates at 10 successive meetings—by anywhere from a quarter to three quarters of a point—as it fought the worst rise of inflation since the early 1980s.
In India, a 30 percent rise in oil prices makes both equities and economy vulnerable as higher oil prices increase utility, freight and transportation costs, adding to inflation. A 10 percent oil price increase is estimated to hit retail inflation by an average 0.2 percentage point. This is an adverse terms-of-trade shock for Asia, since most Asian economies are net oil importers. According to Nomura, if oil prices remain high, it will hurt growth, inflation and worsen both current account deficit and fiscal balances. Also read: Are weak rupee and rising oil big challenges to India's stock rally?
“Even if countries have fuel/energy subsidies in place, higher oil prices will result in a deterioration of the current account and fiscal balances (on-budget or off-budget), due to higher imported costs. We expect a 0.3 pp worsening in the current account balance for every 10 percent oil price rise,” say Sonal Varma and Si Ying Toh, economists, Nomura.
Meanwhile, Indian equities stand to face challenges even with the weakening currency and an expensive valuations of markets. Upcoming elections in 2024 will also bring in uncertainties with economy and markets navigating through a volatile phase.
During the last five general elections in 1999-2019, the Nifty rallied 10-32 percent six months prior to the announcement of election results. India will be going into general elections in March-May 2024.
Pratik Gupta, CEO and co-head, Kotak Institutional Equities, expects markets to stay rangebound in the near term. Due to expensive valuations, he sees limited upside to the markets and limited scope for earnings upgrades and risks from a global slowdown.
It is, however, unclear how lots of macro issues will play out eventually. Rishi Kohli, CIO-absolute strategies, InCred Alternative Investments, feels that higher crude prices or weaker rupee do not always have a negative correlation to markets so undue focus is given to them for medium to long-term market outlooks. “They do lead to some short-term knee-jerk reactions but it does not matter much in the long run. For example, in the 2003-2007 bull market, Indian markets rallied strongly along with crude rallying strongly,” Kohli explains.
However, Kohli adds there is no denying that it’s unclear how a lot of macro issues will play out finally, especially inflation that is sticking to high levels longer than many expectations. “However, markets always ride the wall of worry as they say,” he adds.