Market Volatility Surges Amid Global Yield Spikes and Policy Shifts
Overview
The easy-money period following the epidemic gave stock markets a boost that persisted for years. The complacency brought on by the upward trend remained unaffected. The much-anticipated “soft landing” kept investor spirits high despite the world’s extreme inflation and central banks’ aggressive monetary tightening policies.
However, the market decline has jolted investors after years of complacency, and since the end of September last year, sentiment has shifted sharply to the negative. This is especially valid for developing markets like India. Since its high, the broad Nifty 50 index has experienced a correction of over 10%.
Factors affecting the volatility of Indian markets
China, the world’s greatest producer and consumer of commodities, raised expectations for an economic revival in September 2024 when it unveiled stimulus measures. The emergence of rising commodity prices was the backdrop for inflation to reappear. Trump won the US presidential election within a month of this, and inflation expectations skyrocketed in anticipation of more tariffs, tax breaks, and immigration restrictions. More recently, Brent crude prices have risen above $80/barrel due to the extensive restrictions placed on Russian crude. Despite high interest rates, inflation has increased globally due to several causes. The G7 countries’ average inflation rate has increased from 2.2% in September to 2.6% in November and has continued to rise ever since.
Central banks’ response globally
Paradoxically, at this time, central banks all over the world have been relaxing their monetary policy restrictions. However, markets have continued to brace for monetary tightening due to growing inflation and, more significantly, the uncertainty around future inflation. Furthermore, US rates have increased further due to expectations of a fiscal explosion under the next US president. Thus, yields have increased in the majority of large economies in spite of rate reduction. Despite the policy rate being between 4.25 and 4.5%, 10-year US Treasury yields are approaching 5%, German yields have increased to 2.6% despite their faltering economy, and British yields are at their highest levels since 2008.
Rising yields in the U.S.
At the time this piece was written, US yields were 4.3%, up from 3.6% in September. Strangely, this increase is similar to the “higher for longer” era, when US rates increased from 3.5% to 4.3% in a single month in September 2022 before reaching a peak of about 5% in October 2023. Emerging market assets typically lose appeal to foreign investors as a result of tighter gaps against emerging market yields caused by rising US yields. FIIs promptly sold off around Rs 40,000 crore worth of Indian stocks between August 2022 and October 2023. However, Indian stock markets managed to hold their ground with the help of domestic institutions and individual investors; during this time, the Nifty 50 index increased by 13%.
This time, the increase in yields has caused FIIs to lose interest in Indian stocks. However, the quantum has never been seen before. The broad market index has corrected by about 11% in less than 4 months, and FIIs have sold off Indian stocks valued at an astounding Rs 2.2 lakh crore.
Yield Spikes witnessed in 2022-23
The wave of yield spikes this time around appears to be unique eyeing the state of the Indian economy. Due to strong government capital expenditures, the Indian economy was the major economy with the quickest rate of growth in 2022–2023. However, this time around, India’s halo is somewhat vanishing due to decreasing government capital expenditures and declining consumer demand. In light of this, the RBI must lower interest rates quickly in order to boost the economy and further reduce yield spreads.
Furthermore, the USD has been strengthening in the wake of US policy uncertainties. The dollar returns received by US investors in India have been further squeezed by the ensuing more than 3% depreciation of the Indian rupee, which has reached all-time lows of 86+. In actuality, the INR is expected to weaken even further as India’s imports of crude oil increase in response to Russian sanctions and the RBI progressively reduces its involvement in the currency markets. The real effective exchange rate of INR shows an 8% overvaluation, suggesting that the returns received by US investors in Indian stocks will continue to decline. Therefore, in contrast to 2022–2023, the bubbly Indian stock markets have fallen victim to the most recent round of yield rises.
What lies in the future?
Trump is scheduled to take office early next week, which is expected to open the door for erratic and possibly extreme immigration, business, and trade policies. In light of Trump’s potentially inflationary intentions, the US Fed’s policy decision at the end of this month will be widely scrutinized for indications of incremental hawkishness.
At home, we have three major events in the first few days of February: the Union Budget, which faces the challenge of boosting India’s slowing economy; the RBI’s monetary policy review, which is anticipated to result in the first rate cut after a year of holding rates higher for longer; and the results of the Delhi assembly election.
With so many important events planned for the next weeks, investors shouldn’t expect any respite from the stock market’s volatility.
The image added is for representation purposes only
