ETMarkets Smart Talk | US bonds offer attractive yields again: Nachiketa Sawrikar on the challenge for Indian equities

Global investors are facing a very different opportunity set today. With US bond yields offering attractive nominal returns again, Indian equities are no longer competing only with other emerging markets for global capital—they are increasingly competing with the relative safety and yield available in US fixed income.

The Federal Reserve’s rate hike may be largely priced in, but according to Nachiketa Sawrikar, Fund Manager at Artha Bharat Global Multiplier Fund, the bigger question for markets is what happens to US bond yields and the dollar from here.

The US 10-year yield has already moved sharply higher from its February lows, changing the return equation for global investors.


For Indian equities, this matters because higher US risk-free yields raise the hurdle rate for capital allocation. At the same time, strong AI-related capex is attracting significant capital towards the US, while US Treasuries and high-quality corporate bonds are offering yields that were far less compelling a few years ago. Edited Excerpts –

Q) The Fed has raised rates by 25 bps, but markets were largely expecting it. What does it mean for Indian markets?

A) The 25 basis point increase itself should have limited incremental impact on Indian markets because it was largely priced in before the meeting. The more important development was the Fed's message that the tightening cycle may not be over, with 16 of the 18 participants expecting at least one additional increase this year.

More broadly, we are seeing a shift toward tighter monetary policy across major developed economies, with both the Federal Reserve and the ECB raising rates. This reduces the RBI's room to pursue an easier monetary policy, particularly at a time when India has already experienced significant FII outflows. If global interest rates continue to rise, the RBI may eventually need to consider tighter monetary policy as well to maintain an attractive interest-rate differential, support the rupee and limit further pressure on foreign capital flows.

That is a short-term negative for Indian markets. Longer term, however, if higher short-term rates in the US succeed in bringing down longer-term interest rates, global capital could once again seek opportunities in emerging markets.

Q) For Indian equities, should investors be more worried about the Fed itself or the resulting move in US bond yields and the dollar?

A) We would focus much more on US bond yields and the dollar than on the Fed funds rate itself. Sometimes raising short-term interest rates is precisely what is required to bring longer-term interest rates down.

The 10-year US Treasury yield had risen approximately 100 basis points from its February lows ahead of the Fed meeting. That increase in longer-term rates represents a much greater challenge for global equities than a well-telegraphed 25 basis point Fed hike.

If the Fed can convince markets that it is serious about controlling inflation, longer-term yields could stabilize even as short-term rates rise. That would be a better outcome for Indian and other emerging market equities.

Read more: ETMarkets Smart Talk | Rate-cut cycle over, RBI may be at cusp of rate hikes; yields could inch higher: Puneet Pal

Q) If the Fed delivers another rate hike this year, what could that mean for global risk assets, emerging markets and capital flows?

A) Another increase should not automatically be viewed as negative for global risk assets. The circumstances surrounding the increase will matter much more.

If inflation remains elevated and the Fed raises rates in a controlled and well-communicated manner, it could strengthen the Fed's inflation-fighting credibility and reduce pressure on longer-term yields. Conversely, if inflation continues to accelerate and markets begin pricing a prolonged tightening cycle, higher US yields and a stronger dollar would create a more difficult environment for emerging markets and could result in additional capital outflows.

The distinction is important: the risk for emerging markets is not simply that the Fed raises rates. It is that US long-term rates continue rising and global financial conditions continue tightening.

Q) What does the Fed's latest move mean for the RBI? Does India have enough room to pursue an independent monetary policy?

A) The RBI can pursue an independent monetary policy, but it cannot be completely insulated from global financial conditions. Domestic inflation and growth should remain the primary determinants of Indian monetary policy, while movements in the rupee, oil prices and global interest rates will influence the RBI's room for manoeuvre.

With the US and EU raising rates, and the possibility that other developed economies may eventually follow, the RBI's room to maintain easier monetary policy is becoming more constrained. If global rates remain elevated, the RBI may ultimately have to consider raising rates as well.

That would create an additional headwind for Indian equities, particularly at a time when India is already dealing with elevated oil prices, FII outflows and tighter global financial conditions.

Read more: ETMarkets Smart Talk| Fed, dollar, crude, rupee: The four-way squeeze Indian markets need to watch, Sachin Shah decodes

Q) Does a higher-rate environment make US fixed income more compelling for global investors compared with the previous decade of ultra-low yields?

A) Absolutely. This is one of the most important structural changes in global asset allocation compared with the previous decade.

For much of that period, investors had very little choice but to move out along the risk curve because high-quality

US fixed income offered extremely low yields. Today, investors can earn attractive nominal yields in US Treasuries and high-quality corporate bonds without assuming equity-market or emerging-market risk.

At the same time, the massive AI infrastructure buildout is attracting capital from around the world into the US. The combination of attractive fixed-income yields and extraordinary investment in AI infrastructure makes the US an increasingly powerful competitor for global capital.

That raises the required return for every other asset class. Emerging-market equities, US equities, private equity and other risk assets now have to compete against a meaningfully higher risk-free return.

We are already seeing this adjustment in US equity valuations. The S&P 500's forward P/E multiple has declined significantly this year despite very strong corporate earnings.

For Indian equities, the combination of valuations, earnings growth and competition from attractive US investment opportunities could continue to put pressure on the market, particularly if foreign investors can earn compelling returns in the US without assuming emerging-market risk.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times.)