Updated: February 23, 2021 9:08:39 am
The benchmark Sensex at BSE fell by over 1,000 points or over 2 per cent in the afternoon trading hours on Monday taking the aggregate fall over the last five trading sessions at over 2,300 points or 4.5 per cent. While the Sensex fell below the 50,000 mark, the fall was not limited to Indian markets. Even the primary indices in leading European markets opened lower by 0.8 per cent to 1 per cent on Monday, as rising bond yields impacted equity investment sentiments around the world.
Why are the markets falling?
The markets weakened last week in line with the rise in bond yields both in the domestic and global markets. While the rising bond yields globally have raised investor concerns and have acted as a trigger for fall in equity markets, many feel that a fall in markets led many investors (worried over expensive valuations) to go for profit booking, resulting in a further decline.
The yield on a 10-year bond in India moved up from the recent low of 5.76 per cent to 6.19 per cent in line with the rise in US yields. On Monday, it rose over 1 per cent from Friday’s closing of 6.132 per cent to 6.196 per cent during the afternoon hours.
What is the relationship between bond yield and equity returns?
Traditionally, when bond yields rise, investors start reallocating their investments away from equities and into bonds as they are much safer. As bond yields rise, the opportunity cost of investing in equities goes up and therefore equities become less attractive.
Another important factor is that when the bond yields rise, it raises the cost of capital for companies which in turn compresses the valuations of their stocks.
That is something that investors always see when RBI cuts or raises the repo rate. When it cuts the repo rate, it reduces the cost of borrowing for companies leading to a rise in share prices and vice-versa.
What is its impact on FPI fund flow?
Bond yields play a big role in FPI fund flow. Traditionally, it has been seen that when bond yields rise in the US, FPIs move out of Indian equities. In fact, it has also been seen that when the bond yield in India goes up, it results in capital outflows from equities and into debt.
A higher return on treasury bonds in the US leads investors to move their asset allocation from more risky emerging market equities or debt to US Treasury which is the safest investment instrument. So, a continued rise in yields in developed markets may put more pressure on Indian equity markets as they may witness an outflow of funds. Even a rise in domestic bond yield would see allocation moving from equity to debt.
Will RBI need to intervene?
A report by SBI pointed that while the increase in bond spreads is a manifestation of the nervousness of market players, it said that the central bank will have to resort to unconventional tools to control the surge in bond market yields. “This is important as any further upward movement in G-sec yields even by 10 bps from the current levels could usher in MTM losses for banks that could be a minor blip of a rather wise exceptional year in FY21 bond markets with the RBI assiduously supporting debt management of Government at lowest possible cost in 16 years, that otherwise could have threatened financial stability.”
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