Last week, the RBI kept rates unchanged at 6.5%, for the fourth consecutive time. However, at the same time, the RBI said it may consider the sale of bonds through Open Market Operations (OMO) to manage liquidity conditions, in line with inflation objectives. This sent bond yields higher, which usually results in pressure on the markets.
What’s happening?
Globally, bond yields are inching higher. In the US, benchmark yields hit fresh 16-year highs, after a bond sell-off, as investors were concerned about the Fed’s comments on a possible rate hike towards the end of the year.
Higher rates for a longer duration go against the current market belief of inflation being under control, a ‘soft landing’ for the US economy, an avoided recession, and a possible shift in the Fed’s strategy.
While the RBI maintained rates, its OMO came in as a surprise and sent bond yields higher in India too.
What difference do bond yields make?
There is an inverse relationship between bond yields and prices. When yields go up, either because of rates going up or because of investors wanting a higher reward on the additional risk, prices go down.
Bond yields going up also become a threat to equity valuations, and tend to pressure prices down. Higher equity valuations usually mean lower earnings yield, which when compared to higher bond yields imply lower margin of safety.
Is there a reason to worry?
Not as much as the world has to worry.
The inflation problem is worldwide and all central banks are in the same boat on dealing with it. However, the recession problem is global, and not applicable to India. While the world worries about a possible recession, India’s structural growth factors are intact.
The RBI also maintained India’s GDP projection at 6.5% for the year. Of course, lower global growth could lower the number, but definitely not put it in the negative.
So, for the Indian markets, while higher bond yields could result in pressure on the markets, we have much lesser to worry about.
What should you expect from the markets?
The markets could see some near-term pressure because of higher yields, increased worries on inflation and the impact of lower global growth on India.
However, with relative growth outperformance for India intact and a continual of high earnings growth for corporate India, investors (global and domestic) are likely to continue pumping money into the markets, helping high valuations remain buoyant.