The recent slump in global and Indian stock markets is closely tied to a surge in US government bond yields. When the US bond market experiences turbulence, it creates a ripple effect that pulls money away from stocks worldwide.
How Bonds and Yields Work
When a government needs funds, it issues bonds, which is essentially taking a loan from investors in exchange for regular interest payments. The “yield” is the actual percentage return an investor earns. A fundamental rule of finance is that bond prices and yields move in opposite directions: when bond prices drop, their yields go up. Currently, the US 10-year Treasury yield has jumped from below 4.25% to over 5%.
Why US Yields Are Climbing
Inflation Fears: The US economy has remained unexpectedly strong, which increases demand and the risk of inflation.
Interest Rate Hikes: To fight inflation, the US central bank (Federal Reserve) raises general interest rates. Investors then sell their older, lower-paying bonds, which drives bond prices down and pushes yields up.
Global Conflicts: Geopolitical tensions, particularly in West Asia, are driving up oil prices. Expensive oil increases business costs, further fueling inflation and pushing interest rates higher.
The Stock Market Drain
US government bonds are viewed as one of the safest places in the world to store money. When these ultra-safe bonds start offering high returns of over 5%, investors naturally move their cash out of riskier investments like the stock market. This massive withdrawal of funds causes stock prices to fall.
The Impact on India
Developing nations like India usually offer higher interest rates on their bonds to attract foreign investors and compensate for higher perceived risks. For instance, in late 2023, India offered around 7.18% while the US offered 3.87%.
Shrinking Gap: With US yields now crossing 5% and India’s remaining near 7%, the profit difference has shrunk significantly.
Foreign Withdrawals: Foreign investors are choosing the total safety of the US market over the slightly higher returns in India. As they pull their funds out of Indian equities to invest in America, the Indian stock market takes a hit.
India’s Built-in Protection
While the Indian stock market is feeling the pressure of foreign withdrawals, the Indian bond market remains highly secure. Foreigners own only about 3% of Indian government bonds. The vast majority are securely held by domestic banks, insurance companies, and pension funds, meaning India is shielded from a domestic bond crisis even as foreign investors exit.