Sensex Crashes 769 points as US Bond yields soar, scaring both bond and equity players
Moneylife Digital Team 16 August 2013

As the US Treasury yields soared to their highest in two years yesterday, foreign investors sold off bond and equity, pushing rupee to an all-time low of Rs62/$ 

The Sensex today fell by a huge 769 points, a selloff that has no apparent reason except that the rupee weakened a bit more. Rupee has been weak for the past two months and today it weakened by 0.77% to 61.99. What caused this massive selloff, when Rupee had already closed at Rs61.54 on August 6th?
 

One of the most important reasons lies in little-discussed US bond market. Yesterday, August 15th, the 10-year US Treasury yield touched 2.823%, its highest level since August 2011. The US Labour department on the day reported that the total number of Americans filing for unemployment benefits for the first time last week fell to a near six-year low.  A week back we had mentioned to keep an eye on US Treasury yields (Read: Rupee Weakness: Its not just CAD, keep an eye on US 10-year yield). US Yields are rising because of fears that the Federal Reserve may start tapering its bond-buying programme of $85 billion a month. As US economic data continues to improve, this has led to a sell-off in the US treasury market, on expectations that the Fed will pull back its monetary stimulus program. What does this have to do with Indian market?
 

In the Indian market, over the past five trading days, foreign institutional investors (FIIs) have sold over Rs6,500 crore of bonds in the debt market. The 10-year Indian Government bond yield was up by 36 basis points from 8.14% as on 8th August to close at 8.50% on 14th August.



 

The Indian economy has become too dependent on foreign capital. In the past few months we have seen a heavy outflow from the debt markets because of rising US yields, weakening the rupee. The central banks efforts to tighten liquidity in order to boost the rupee have turned out to be fruitless in the face of such huge outflows. In the past two and a half months there has been an outflow of over Rs50,000 crore of foreign investments from the Indian debt market. As seen in 2007-08, the rupee appreciation happened mainly due to FII inflows into the capital market in India.
 

What next? US Treasury bond yields are near their lowest levels in the last two decades. With the recent uptrend in yields and with signs that the Fed may end its stimulus programme, will yields continue to trend higher? Rising US yields would make emerging market bonds look even more unattractive leading to massive sell-off from bond markets of these countries, leading to a further weakening of rupee. That is the worry for FIIs, making them sell.
 

Unlike equity markets, where investors look for the long term rise in value thanks to rising corporate profits, in debt markets a few basis points difference could inflict losses with little chance that holding the bonds for the long term would turn a loss into a profit.
 

Also, given India’s current economic situation with a high current account deficit, rising inflation and depreciating rupee it would be highly unlikely for the Reserve Bank to cut interest rates soon and bond yields would fall. FIIs have a total investment of $28,700 million as on 14 August in the Indian debt market. This has come down from around $37,400 million as on the end of May 2013. There is still a huge amount of assets of FIIs in the debt market and this leads fears if they continue to sell their investments. This has caused fear and panic in the minds of investors, especially the FIIs and this is one of the reasons there has been a massive sell-off in the equity market as we have seen today.
 

 

The inefficiency of the UPA-2 government does not give any hope. Exports are weak, foreign investment has slowed down and India is mainly dependent on FII capital inflows for equity and debt. There is no immediate solution to India’s fundamental problems of a wide current account deficit and funding this deficit in an uncertain global economy through capital account. As long as US bond yields keep rising on better US economic data, we may see further outflows from the Indian debt market which would lead to a weaker rupee and weaker stock prices, under the current correlation. Conversely, a weakening of US bond yields will set up a corrective rally.

 

Also Read:

Weak FII inflows enough to weaken the rupee
 

Watch FII debt flows for rupee volatility

Comments
Dr anil k kothari
8 years ago
iT IS SENSEX WHICH is BEING manipulated otherwise the stock prices are far below the Oct 2008 levels.The economy is in worst situation than 1991 on all except FE reserves front but their is huge amount of hot money in the Fe reserves. we need some structural changes. First to reduce fiscal deficit the Govt expenditure must be cut. It can be reduce by curtailing the no of cars in any carcade should not be more than three. freeze on DA.Reduction in salary by better goverenance and outsourcing function which are not necessary just like Ticket booking by railways, closing down loss making Airline and other PSUs which has become drain on exchequer.Sell surplus land available with Railways, and other institutions.State govt can also be asked to reduce expenditure. freebeeis must be curtailed. Misuse of subsidies must be reduced.
pravsemilo
8 years ago
And this morning in the pre-opening session, the CNBC anchors were congratulating themselves for the resilient opening despite the weak global cues. And there were the analysts who were predicting the Nifty range of 5600-5900.
MOHAN
Replied to pravsemilo comment 8 years ago
If you ask the analysts about the crash, they would reply with a fusty smile "that's stock market".
Vinayak Bhimarao Mudholkar
8 years ago
Is Us economy really improving?....then why Detroit?....Isn't it on steroids?
Abhijit Gosavi
Replied to Vinayak Bhimarao Mudholkar comment 8 years ago
The US economy has its foundations intact: there is a pretty strong infrastructure and a lack of corruption. These factors encourage new businesses to grow and then thrive (at the cost of old businesses, e.g., Detroit). Plus, the US carefully controls inflation. If you allow the sort of horrible inflation that exists in India, the rupee will keep sliding, and there will never be an improvement in the economy. The Sensex/Nifty are just reflecting this reality.
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