US Fed Rates v/s Nifty

Mohit Bhandari -

What are Government Bonds?

When a person is in need of money, they approch the banks. Similars, when the government needs money to fund developments, they have 2 options:

  1. Borrow Money from Central Bank 🏦
  2. Issue Bonds to raise loan from Public 🧾

Bond Yield is a term that relates to the return on the capital you invest in a bond.

How are Bonds linked with Equity Returns?

Bonds Yield is an important determinant for returns on equity. It represents the opportunity cost of investing into equities 💯

For Example, if the 10 year bond yield is 8%, then an investor would look upto equity only if it gives a return over 8% in the same period. And since equity markets are risk associated, investors also add a premium of risk to their investment, example 4%, so only if the expected returns of equity if 12% (8% + 4%) it becomes a favourable bet for investors

So, during the time of inflation, increase in the price of Raw Materials, rise of unemployments and other factors lead to contraction of profit margines for companies which eventually impact their stock price. Also the government, tends to increase the interest rates to curb inflation, which makes bond market more favourable for investors.

US Bond v/s Nifty

The questions here arises are:

  1. Even through US is a developed nation with limited growth while India is a developing Nation with huge opportunities, then why Investors tend to invest in US Bonds?
  2. Even though the US bond yields much less than Indian Bonds, why investors move to US bonds in times of Uncertainities?

The only answer for both the questions is, any changes in the US bond yield has a direct impact on Currency Carry Trade, due to which investors inflow into US Bond market.

Lets Underatand this with an example 📝

Josh is a foreign Investor who wanted to make his life easy, so he took a $ 1million loan from US at 4%, converted it into Rupees (Rs. 8 Crores at $1 = Rs.80) and invested it into Indian Bonds at 7%. Making him an easy 3% profit (Rs. 24 Lakhs).

Impact of rise in US Fed Interest rate:

  • Equity Markets will seem less attractive due to high and guranteed returns in Bonds. And thus, the FII’s will pull-off from Indian Stock Market.
  • Rise in Fed Interest Rates will have a negative impact on Rupees. Suppose the value falls down to $1 = Rs.82. In the above example, when Josh sold the bonds at Rs. 8.56 Crores and converted to Dollar, the value was just $1.44million, whereas the rise in interest rates will require Josh to pay $1.45million, making him a loss of $0.01million 😭
  • This Fall in rupees leads to higher import costs, lower profit margines, higher product costs, leading to rippel effect in the economy.

Conclusion

The Fed rates does not changes overnight and there are a lot of news and speculations about the same from month back. This provides retail investors to put cushions and prepare themselves for the hit.

To avoid any major impact RBI takes steps like increasing the REPO rates to curtail inflation. Just like the hikes of US Fed Interest rate leads to a negative impact in Indian Stock market, similarly, the rate cutes leads to fresh inflow of investment from FII’s in the market💪