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India: Infrastructure Set to Outpace IT as the Growth Engine
Business, Equities, Markets - January 17, 2025

Market Volatility Surges Amid Global Yield Spikes and Policy Shifts

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.

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Global Rate Cuts and its Implication’s on Indian Markets

Global Rate Cuts and its Implication’s on Indian Markets

The Indian stock markets are on the brink of significant gains as global central banks are expected to initiate a cycle of rate cuts. This optimistic outlook is driven by a convergence of favorable domestic and international factors, including robust economic growth, a stable political environment, and, most notably, the anticipated easing of monetary policy across major economies. As global financial markets brace for lower interest rates, India’s equity markets are likely to be among the key beneficiaries.

After years of strict monetary policies meant to contain inflation, central banks all over the world are indicating rate decreases, which is a significant change in the global economy. The main causes of this change in attitude among investors are the economy’s slowing growth, ongoing inflationary pressures, and geopolitical unpredictability.

Interest rate cuts are a tool used by central banks to encourage borrowing and investment. By lowering the cost of borrowing, central banks aim to stimulate economic activity, increase consumer spending, and ultimately drive economic growth. The expectation is that lower interest rates will lead to increased investment by businesses, more spending by consumers, and, consequently, higher demand for goods and services.

The transfer of capital across national boundaries is one of the most direct consequences of global rate reduction. Investors frequently look for better returns in developing markets when interest rates in established economies decrease, which increases capital inflows into nations like India. When foreign investors buy Indian bonds and stocks, asset values rise and stock markets benefit.

For emerging markets like India, lower global interest rates are a boon. Rising capital flows into developing countries are usually the consequence of rate reductions in developed economies, as investors seek greater profits.
India, with its strong economic fundamentals and attractive growth prospects, is well-positioned to attract a significant share of these inflows. This influx of foreign capital is expected to provide a substantial boost to Indian equity markets, driving up stock prices and enhancing market liquidity.

Investor sentiment in India has been increasingly bullish, driven by a confluence of factors. The consistent performance of Indian equities, particularly in sectors like technology, pharmaceuticals, and consumer goods, has instilled confidence among both domestic and international investors.
Many Indian companies have reported better-than-expected quarterly results, reflecting robust demand and effective cost management. This trend is expected to continue, especially in sectors that are poised to benefit from global rate cuts, such as real estate, infrastructure, and financial services.

While global rate cuts can provide short-term boosts to the Indian economy through increased capital inflows and stock market rallies, there are long-term implications to consider. For instance, excessive dependence on foreign capital can make the Indian economy vulnerable to external shocks. If global investors suddenly withdraw their investments due to changes in global monetary conditions, it could lead to a sharp correction in Indian markets, potentially destabilizing the economy.

While the outlook for Indian stock markets is largely positive, investors should remain cautious of potential risks and challenges. Global economic conditions, while improving, remain fragile. Any unexpected developments, such as a sudden escalation in geopolitical tensions or a resurgence of inflationary pressures, could disrupt financial markets and dampen investor confidence.
While global rate cuts are expected to benefit Indian markets, they could also lead to increased volatility. Rapid inflows of foreign capital, while beneficial in the short term, could create asset bubbles if not managed carefully.

In conclusion, Rate reductions throughout the world have mixed effects on the Indian economy. They can have short-term advantages like capital inflows, stock market gains, and the possibility of domestic rate reduction, but they can also have drawbacks like instability in the currency, inflationary pressures, and susceptibility to outside shocks. India has to be cautious about the dangers and maintain a balanced approach in order to take advantage of the possibilities presented by the global rate decreases. To guarantee sustained economic growth, India’s authorities must continue to be proactive in regulating these dynamics as the world’s monetary circumstances change.

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