US 10-Year Bond Yield Nears 5%: How Will It Impact Indian Markets, FPI Flows?

The US 10-year Treasury yield has climbed to 4.80 per cent, its highest level since November 2023. Investors are now watching closely to see if it crosses the 5 per cent mark. For most investors, this may sound like a number that matters only in the US bond market. But a rise in US bond yields can also affect Indian markets. Its ripple effects can influence foreign investor flows, the rupee, Indian bond yields, stock prices, and the retirement savings of anyone with money in Indian mutual funds.

Why a Number on a US Bond Chart Matters Here

Investors around the world, including in India, closely watch US government bond yields. US government debt is considered one of the safest investments. So, its return is used as a benchmark when investors decide where to put their money.

When US Treasury yields rise, other investments have to offer better returns to remain attractive. This can make Indian stocks less appealing to foreign investors, especially when US bonds offer higher returns with relatively low risk.

Sandeep Neema, director and fund manager at PL Asset Management said rising US yields can make foreign portfolio investors (FPIs) more cautious about Indian equities. He said, “Rising US yields directly raise the discount rate foreign investors apply to emerging-market equities, including India, making the relative return math less favourable versus US treasuries and US equities in the short run. This is compounded by a firmer dollar, which erodes the currency-adjusted return for unhedged foreign holders.”

The USD/INR pair has risen nearly 1 per cent to 95.16, showing that the rupee is facing fresh pressure against the dollar.

A weaker rupee also makes imports more expensive for India, especially crude oil, which is largely bought in dollars. If the rupee stays weak, it could increase the import bill and add to inflation.

When the dollar gains against the rupee, FPIs can lose part of their returns when they convert their investments back into dollars.

So, higher US yields and a stronger dollar can make Indian markets less attractive for foreign investors and put pressure on FPI flows.

Bonds Are Already Feeling The Pressure

The impact is already visible in India’s bond market. Rise in US bond yields and higher crude oil prices are putting pressure on Indian government bonds. India's benchmark 10-year government bond yield is hovering near the 7 per cent mark. As at 11 am on September 9, it quoted 6.95 per cent.

For bond investors, rising yields can be a concern because bond prices and yields move in opposite directions. So, as yields climb, the market value of older and lower-coupon bonds falls. When yields rise, the prices of existing bonds fall. This means investors holding older bonds may see the value of their investments decline.

Longer-duration securities take the biggest hit on a mark-to-market basis. Freshly issued government bonds do become more attractive at higher yields, but investors who already hold older bonds could still face losses if they sell them at current market prices.

Which Stocks are Most Exposed

Higher US bond yields can put pressure on stock valuations, particularly those trading at expensive levels. When safer US assets offer better returns, investors tend to demand more from riskier assets, such as equities.

That does not mean the entire market will come under pressure. If India’s economic growth and corporate earnings remain strong, investors may simply rotate out of richly-valued stocks and into companies with steadier cash flows and more reasonable valuations, rather than trigger a wholesale sell-off.

The FPI Calculus

FPIs have already turned net sellers of Indian equities in recent weeks, a shift that coincides with the rise in both crude and US yields. Ajit Mishra, senior vice president of research at Religare Broking, said: “Higher US yields improve the relative attractiveness of dollar-denominated assets, while a stronger dollar raises the currency risk associated with emerging-market investments. Consequently, foreign investors may adopt a more selective approach towards Indian equities and moderate fresh allocations until global rate and currency conditions stabilise.”

Mishra also flagged that the level of yields is not the only thing that mattered. The pace at which yields rise is equally important. “The key issue is not merely the absolute level of yields, but the speed and direction of the move, which can materially influence portfolio flows and risk appetite,” he said. A gradual move towards 5 per cent may not rattle Indian markets, but a sudden jump to that level could, he added.

Neema said the strong link between US markets and Indian equities also has a structural reason. He said a large share of FPI assets under management tracking Indian equities is domiciled in the US, so the dynamic of rising US bond yields and stronger dollar “tends to show up quickly in flow data”. That could also help explain why Indian outflow numbers can move almost in lockstep with US Treasury moves, even when nothing in India’s own growth story has changed.

This is why FPI outflows from India can move almost in tandem with US bond yields, even when nothing in India’s own growth story has changed.

Crude Oil Adds to the Pressure

The rise in crude oil prices is making things tougher for India. Brent crude has climbed to a six-week high and is trading above $99 a barrel, up nearly 13 per cent in the past two weeks as the war in West Asia has intensified. India imports more than 85 per cent of its oil needs, so any sharp rise in crude prices means a bigger import bill and more pressure on the rupee. A weaker rupee also makes oil imports even more expensive.

The bigger concern now is inflation though. Higher crude prices and a weaker rupee can drive the cost of fuel and other imported goods higher. That could leave the Reserve Bank of India (RBI) with less room to cut interest rates and may bring back concerns about a tighter monetary policy.

What Investors Should Watch Next

The next big trigger for markets is around the corner. The US producer price index (PPI) and consumer price index (CPI) inflation data are due on September 10 and 11, respectively. Investors will be watching the numbers closely for clues on the US Federal Reserve’s rate outlook and the direction of US Treasury yields.

Mishra said, “A hotter-than-expected US inflation print would likely reinforce expectations of a more cautious Federal Reserve and could push US Treasury yields and the dollar higher. For Indian equities, this would create a near-term headwind through potentially weaker foreign portfolio flows and pressure on the rupee.” He expects the impact to be felt mainly across “rate-sensitive and globally exposed segments”. The extent of the market reaction, however, will depend on how much the inflation data differs from what the Fed is expecting.

What Should Investors Do

India is not without buffers. Steady, month-on-month (m-o-m) inflows through systematic investment plans (SIPs) and continued participation from domestic institutional institutions (DIIs) have repeatedly cushioned the market against bouts of FPI selling this cycle. Further, the RBI’s intervention has helped cushion the rupee as global pressures weigh on the currency.

Neema believes investors should stay patient rather than panic. “India’s growth premium over the US remains intact, and once the yield and dollar move stabilises, we would expect allocators to revisit India on relative growth and earnings grounds rather than purely on the rate differential,” he added.