The Dollar carry trade in Indian debt and equity markets gets affected when yields move sharply in U.S.
Let’s not delude ourselves, FIIs still are instrumental in providing liquidity to Indian markets and hold the key to any major moves. Equities have been correcting since March 2015 and one quick look at FII data for equities and debt shows how their interest has been on a decline since February. May even witnessed negative flows.
Many theories are being put forth explaining the correction in Indian equities. From FIIs losing faith in India story to dismal corporate earnings etc. It’s easy to buy into theories when markets are sliding down the slope of hope. But the larger clue lies with the chart above of the benchmark U.S. 10 year bond yield. I have pointed out this factor very often and here I will explain it in greater detail. The dollar carry trade gets affected when yields rise in the U.S. To simplify, FIIs who have borrowed cheaper money in the lower yield U.S. markets and have deployed in high yield Indian markets, start to pull out their money from India. They want to lock in their profits from India and want to buy the highly rated US bonds, which are now available at higher yields. This is a very common and popular strategy employed by hedge funds.
As always, bonds lead equities. Note that bond yields are inversely related to bond prices. So higher yields means lower prices. Till bonds see further buying, expect the equities to underperform or at best stay sideways, like they have been for the past few months. Since we are reviewing the chart of US 10-year yield in this post, take a glance at how the SPX or DJIA fared, for example. Even with the dip that came by in the last week after the FOMC announcement, this weekly timeframe chart is in a clear uptrend. That has to change if the equities are to make a clear break upwards.
Our team has highlighted this interesting technical analysis of the 10-year yield chart based on the DeMark indicator. The DeMark 13 bar sequential countdown caught the bottom almost to perfection at the start of 2015. Since then yields have headed higher. As a sign of rising momentum it is close to completing a 9 bar TDST setup on the upside. For the time being, 1.895 is our reference level for signs of a meaningful reversal. Reason is that as per the DeMark system this is the true low of the currently forming 9 bar TDST range. Simply put, at present there is no sign of reversal even if we see a pullback or two. If yields continue to slip further to last week, we will see further strength in US equities. And then in Indian equities too.
Classical technical analysis enthusiasts will notice the Golden Cross that has just happened when the 50 DMA crossed above the 200 DMA. Another sign that a medium to long-term uptrend is in place. Till we start to see meaningful pullbacks equities will remain subdued.
To understand the direct impact of the U.S. treasuries on Indian markets, its important to look at the charts of Indian 10-year bond yields and the USDINR…especially last week’s. Note the sharp dip in both the yields and USDINR, in line with the dip in US 10 year yield. And right on cue Indian equities posted smart gains for the week gone by.
7.652 is the reference level for Indian yields since it is the true low formed while a 13 bar weekly DeMark sequential countdown formed. A breach below this level would signal that a durable bottom is still not in place. Which in turn will be a positive for equities and debt markets.