BackWill rising US bond yields cause more FPI outflows from emerging markets? here's what experts say
US Treasury yields spike due to strong economic data, delaying rate cuts by Federal Reserve. Rising crude oil prices sustain inflationary pressures, leading investors to doubt rate cuts. Market experts predict reallocation to higher-yielding bonds from equities, potentially impacting EMs.
PremiumUS Treasury yields have seen a strong spike in recent sessions, driven by various factors that have shifted expectations regarding Federal Reserve rate cuts.
The strength of US retail sales data, coupled with an unexpectedly high inflation reading for March and robust employment figures, have all contributed to the belief that the Federal Reserve is adopting a cautious stance towards reducing interest rates in the near term.
At the start of 2024, analysts had projected as many as three rate cuts by the US Federal Reserve for 2024. Given the strong retail data and elevated inflation print for March, analysts anticipate that the Federal Reserve may delay rate cuts until July or September instead of June.
Meanwhile, the continued upward trajectory in crude oil prices, with some market experts predicting a rise to $100 per barrel amid escalating tensions in the Middle East, is likely to sustain inflationary pressures in the near future.
As a result, investors are becoming increasingly skeptical about the possibility of rate cuts. Currently, several other factors are contributing to the surge in crude oil prices.
These include supply cuts by OPEC members and Russia, as well as escalating demand from major economies like the U.S. and China. This situation has resulted in a significant imbalance between supply and demand in the oil market.
Also Read: Boiling oil menaces macro math, market outlook
Meanwhile, the US retail data, which was released on Monday, jumped 0.7% month-over-month in March 2024, surpassing forecasts of 0.3%, as per the recent media reports. This shows that consumers continued to spend at a faster pace than anticipated despite borrowing costs at a 23-year high.
Following this, the US 10Y bond yields jumped 14 basis points to 4.66% to record the highest level in 2024 in the previous trading session, and it was also the highest level in the last five months. In the current month so far, the yield on the 10Y bond has jumped from 4.21% to the current level of 4.65%.
According to the market experts, the rise in US bond yields could prompt investors to reallocate their funds from riskier assets, potentially triggering capital outflows from equities in favour of higher-yielding bonds.
This trend may also contribute to foreign institutional investors (FIIs) divesting from emerging markets such as India.
Also Read: Why you should invest in Indian stock market despite Iran-Israel tensions, delay in rate cut
LiveMint sought the views of analysts on the potential impact of increasing U.S. bond yields. Here are their responses:
Vinit Bolinjkar, Head of Research, Ventura Securities
The rise in US bond yields could lead to foreign portfolio investment (FPI) outflows from emerging markets like India. When US bond yields rise, investors can earn a higher return by investing in US bonds compared to emerging market bonds. This can incentivize FPIs to pull their money out of emerging markets and invest it in the US. Rising US bond yields can also indicate a flight to safety by investors. This means investors may prefer the relative safety of US bonds over riskier emerging market assets during times of economic uncertainty.
However, considering the fact that India is the only large market with strong growth potential, citing a lack of global opportunities, we expect money to flow back quickly when the markets stabilise.
Also Read: FPIs pump ₹13,347 crore in Indian equities, debt flows reduce in April so far
Speaking on the rate cuts by the US Fed, he said, " It is unlikely that the US Fed will cut rates in the near future following strong inflation data in March. The Federal Reserve's primary objective is to maintain price stability. With strong inflation data, the Fed is likely to prioritize raising interest rates to curb inflation rather than cutting them. The next meeting of the Federal Open Market Committee (FOMC), the policymaking body of the US Fed, is scheduled for May 3rd–4th, 2024. Investors will be closely watching this meeting for any signals from the Fed on future rate hikes."
Dr Joseph Thomas, Head Research, Emkay Wealth
The rise in US bond yields will propel FPI outflows, but only in the early stages of a US rate hike will there be a flow of funds into US dollar-denominated assets. We have already passed by the peak US inflation and peak US rates as things stand at present.
The higher probability at this juncture is for US rates to start coming down. Due to persistency in some of the inflationary components, the US rate cut is getting postponed. Therefore, what is material is the timing of the US rate cuts and not the certainty of the event. In these circumstances, the likelihood of any major outflows from emerging markets can be ruled out unless the safe haven status of the US dollar comes into play due to geo-political risks. As US rate cuts start happening, inflows from US dollar-denominated assets into emerging markets could be expected.
Also Read: India 10-yr yield settles at 7.17%, reports biggest jump in 6 months: Here's why
Commenting on the rate cuts by the US Fed in the near term, Joseph Thomas said, "Persistent inflation is a recipe for economic slowdown, and the US may face issues around slowdown in economic growth in the later stages, and therefore, a rate cut may be required over the next one quarter. The Fed had, in fact, delayed the rate hike, stating that inflation was transient. But the exact opposite was economic reality. Despite some indications of a strong economy, which may gradually wither away, the Fed may take rate action earlier than expected."
Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.
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