Bond market going through a rough patch; should equity investors be worried? Experts weigh in

The global bond markets are going through a rough patch. The benchmark US yields hit fresh 16-year highs after a bond selloff amid growing concerns that if interest rates remain elevated for a longer period, it will slow global economic growth and deal a severe blow to riskier equities.

However, the rout in the US Treasury later cooled on a lower-than-expected US private payrolls report. Meanwhile, the yield on the 10-year US Treasury note rose to 4.75 per cent on Thursday.

Notably, bond prices and bond yields (the returns you get when you buy a bond) move in opposite directions. This means that when bond prices rise, yields fall, and when bond prices fall, yields rise.

For example, when you purchase a 10-year bond valued at ₹1,000 with a 10 per cent coupon rate, you receive ₹100 in annual interest. However, if the bond's price declines to ₹800, the effective yield on the bond increases to 12.5 per cent. Conversely, if the bond price rises to ₹1,200, the bond yield decreases to 8.33 per cent.

Bond market movement impacts the equity market also. If the yields on the US bond yields rise, it is negative for the Indian equity market since it can cause heavy foreign capital outflow.

Also Read: Bond yields spike amid bets of interest rates staying higher for longer; how will it impact Indian stock markets?

Should equity investors be worried?

V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services pointed out that the bond market rout of this magnitude which pushed the yield on a US 30-year bond to 5 per cent was unexpected.

"Wrong market positioning caused this massive selling. Now the market is positioning for a ‘higher for longer’ rate regime," Vijayakumar observed.

Vijayakumar believes the selling of bonds appears to be a bit overdone as he underscored yields have softened a bit after the rout and the 5 per cent crash in crude prices also has helped in pushing the dollar index below 107.

"Going forward the trend in the bond market will depend on the Fed’s stance which, in turn, will be decided by inflation, growth and jobs data in the US," said Vijayakumar.

Santosh Pandey, President and Head of Nuvama Professional Clients Group is of the view that the ongoing increase in the US bond yields may result in a further decline in the Indian equity market.

"Historically, there has been a negative correlation between equity valuations in India and US bond yields. The movement in the US treasury bond yields affects the Indian equity market through Foreign Portfolio Investments (FPIs). When bond yields rise in the US, FPIs tend to withdraw their capital, resulting in a decline in the market’s P/E multiple," said Pandey.

"A similar scenario was seen in the previous month where foreign portfolio investors turned net sellers and withdrew nearly ₹14700 crore, the most significant outflow since January 2023. This resulted in a drop in Sensex and Nifty by nearly 4 per cent from their peaks of 67,839 and 20,192 seen on 15th September. Going forward, we expect the market weakness to persist for the next couple of weeks until the global headwinds recede and the second quarter earnings season in India commences which is expected to maintain a stable growth momentum," Pandey said.

Also Read: Inclusion of Indian bonds in JPMorgan bond index to have limited impact on Indian bonds, rupee, says ASK Wealth

Aryaman Vir, CEO of WiseX pointed out that the US bond market rout is a dramatic event with a variety of contributing factors, including aggressive interest rate hikes by the Fed, rising inflation and a slew of hawkish comments by Federal Reserve officials.

"While the bond market rout is a concern for investors, it is important to remember that market downturns are a normal part of investing. Investors can protect themselves during a market downturn by diversifying their portfolios, investing in high-quality companies with strong balance sheets and having a long-term investment horizon," said Vir.

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Shrey Jain, Founder and CEO of SAS Online pointed out that the economic signals from the US are unfavourable.

"Skyrocketing bond yields, a strong dollar index, and increasing Brent crude prices are causes for concern. Moreover, the consistent selling by foreign institutional investors (FIIs) adds to the apprehension. If the US market experiences a significant decline, it will undoubtedly affect the Indian market too," said Jain.

"Given this difficult situation, it is vital for equity investors to be vigilant. Employing robust risk management techniques, including setting stop losses, becomes essential in safeguarding investments," Jain said.

Akshat Garg, CFA, CFP, Senior Manager - Research at Choice Wealth Private Limited underscored that the US Federal Reserve's relentless campaign to combat inflation through interest rate hikes over the past 18 months has caused a significant disruption in capital markets, resulting in bond yields soaring to levels not witnessed in over a decade.

Garg said the initial expectations of interest rate cuts by the end of 2023 have been overturned by the latest data, indicating a prolonged period of elevated interest rates. This indicates borrowing costs are poised to remain exorbitantly high for consumers, businesses, and even the federal government. This, in turn, is expected to curtail spending and capital expenditure, subsequently impacting equity prices.

"The escalating borrowing costs have reached historic highs, placing substantial pressure on corporate profits and ominously threatening to plunge the economy into a recession, a prospect we had hoped to evade. While Indian equity markets may not experience an equivalent magnitude of upheaval, some turbulence in portfolios is anticipated," said Garg.

"Equity investors should view this as a strategic 'buy on dip' opportunity, capitalising on favourable price levels or adopting monthly systematic investments to harness the benefits of long-term investing, all while remaining steadfast in the enduring narrative of India's growth story," Garg said.

Kedar Kadam, Director - Listed Investments at Waterfield Advisors underscored the market participants so far have been reluctant to believe the Fed’s projections for rates to be kept high and have continued to price in cuts for next year. However, the stubbornly high inflation in food, shelter, and energy prices, coupled with relatively strong macro readings indicate that interest rates would stay higher, for longer.

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