US bonds, booking profits in emerging markets (EMs) like India and repatriating some of their gains to the safety of the dollar. Their sharply reduced purchases of Indian equities so far this month correspond with a global equity selloff prompted by Fitch Ratings’ downgrade of the US sovereign rating which spurred rallies in Treasury yields and the dollar. Last week, Fitch Ratings cut the US’s sovereign credit grade one level to AA+ from AAA, two months after it warned the rating was under threat due to oft-repeated political standoffs on the debt ceiling.
While the downgrade might have been the trigger for the slowing pace of foreign fund buying, the narrowing gap between Nifty earnings yield and the 10-year US bond presaged their caution. Against an average monthly net purchase of ₹31,400 crore through March to July, they net bought equities worth a modest ₹285 crore during 1-7 August. That depends upon how the spread between the Nifty earnings yield and the US 10-year bond moves.
Essentially, when the 10-year US yield outperforms the Nifty earnings yield, narrowing the spread, foreign portfolio investors (FPIs) tend to sell risky EM assets to park their funds in the safety of the US dollar bonds. The earnings yield here is the 12-month Nifty earnings divided by share price (inverse of the price to earnings or PE ratio). The current Nifty earnings yield is 4.5% and the 10-year bond yield is around 4%, translating into a spread of 0.5%, against a 0.74% average spread over the past one year.
A year ago, the yield was at 4.26% and the US bond was at 2.75%, or a 1.51% spread . When the spread was 1.51%, FPIs net invested ₹51,204 crore in Indian shares, the highest since December 2020 and a figure not seen since then. Since
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