Rise of US rates, strong dollar worry markets

Nervousness in Indian markets is creeping in across all asset classes as US 10-year treasury yields touch 3 per cent after four years and the dollar starts rising from its multi-year lows.

The recent rise in portfolio outflow could be an indication of future strain in the system, even as investors are well informed about the pace of normalisation of monetary policies in developed nations.

The rupee on Wednesday tumbled to a 14-month low, while bond yields hardened and equities fell on continued pull-out by foreign investors from various asset classes.

So far in April, foreign portfolio investors (FPIs) have sold $2.05 billion equivalent in equities and debt. As a result, the rupee is under pressure and is currently the second-worst performing major currency in Asia, falling 4.52 per cent so far in 2018. Only the Philippine peso has declined more at 4.6 per cent. The dollar index, which measures the dollar’s strength against major global currencies, rose to 91.153, up 0.43 per cent from its previous close. The rupee closed at 66.91 to a dollar from its previous close of 66.11. The 10-year bond yields closed at 7.74 per cent, up from 7.69 per cent.

The Sensex, too, fell 0.33 per cent to close at 34,501 while the Nifty50 index slid 0.4 per cent to 10,571. These declines were modest because of gains in technology stocks.

Most European and Asian markets fell over 1 per cent, tracking the near 2 per cent fall on Wall Street overnight. FPIs sold shares worth ~3 billion, while their domestic counterparts provided counter-buying to the tune of ~4.6 billion.

“US 10-year treasury yields touching 3 per cent is a psychological barrier, which has been broken, but the path to higher rates began since the beginning of 2018. Global rates have been on an ascent since January, especially US rates. Dollar rates have gone up by 30-40 bps since the beginning of the year,” said Manish Wadhawan, managing director and head of fixed income at HSBC India.

According to Ramkamal Samanta, vice-president, investments, at Star Union DaiIchi Life Insurance, foreign investors mainly hunt for equity assets in emerging markets, more than debt, and therefore, the rise in US yields does not pose a direct threat. But it hits us (India) in a circuitous way, he added.

“If US yields rise at a time when India’s trade deficit is widening, fiscal stress is mounting, global crude prices are on the rise, and the rupee is exhibiting a depreciating bias, many FPIs will put their money in US assets, which leaves more supply of debt in the local market and, therefore, domestic yields rise,” Samanta said.

The rise in US yields though has direct implications for Indian borrowers in international markets as the borrowings are linked to US treasury yields.

“In fact, they have been impacted even more by the widening of spreads on Indian credit, taking their costs higher by around 60-70 basis points in the last four months,” Wadhawan said.

“If the US rates climb higher, they might impact fresh allocation to emerging markets, including India, resulting in sluggish FPI flows. With oil and commodities also running up, it can have some negative impact on the rupee too,” he added.

Reserve Bank of India Deputy Governor Viral Acharya has already expressed his concern over rates and has said he might vote for withdrawal of accommodation during the June monetary policy. Economists say with two of three RBI members in the monetary policy committee rooting for a rate hike, it could be a matter of time before consensus builds around a hike.

Deutsche Bank economist Kaushik Das said in a note on Wednesday that the RBI would start hiking rates from June. This would mean bond yields would push up further at a time when banks are not interested in investing in fixed income paper for fear of mark-to-market losses.

Banks are currently mandated to invest 19.5 per cent of their deposit base in government securities. But some estimates suggest banks’ present holding of government bonds could be as high as 29 per cent, which clearly works as a disincentive for banks to invest more. The FPI outgo and the reluctance of banks would mean the yields would likely head northwards quite quickly.

This will have implications for private companies trying to tap the bond market for funds. Short-term rates have already risen substantially for them.

Things are not looking particularly rosy for the equities markets either. But exports are rejoicing on weakening rupee.

Shares of Tata Consultancy Services (TCS) gained 2.43 per cent, while Infosys gained close to 1 per cent amid a weakening rupee. Banking and metal shares led the declines, with ICICI Bank and Tata Steel falling nearly 2 per cent each.

“The market slid as rising global bond yields and a weakening rupee hurt investor sentiment. Besides, metal shares also lost their sheen. On a positive note, the IT index outperformed as a strengthening dollar and improving outlook kept counters attractive,” said Vinod Nair, head of research, Geojit Financial Services.