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US 10-year bond yield has risen almost 100bps to reach ~3.6% since Aug’22 on the incrementally hawkish stance of the US Fed although 10-year India bond yield has remained flat. Consequently, the spread of 10-year bond yield of India over US has reached ~360bps, which is the lowest since Aug’09.

Spread of 10-year bond yield of India over US has a largely positive correlation with the P/E of NIFTY50 based on data for past two decades with very few exceptions. In other words, as the spread of 10-year bond yield of India over US increases / decreases, the valuation of the NIFTY50 index expressed in terms of forward P/E has historically shown an increasing / decreasing trend. Going by the correlation for the past 20 years, the recent decline in spread can potentially put pressure on the P/E multiple of the NIFTY50.

India’s ‘growth-inflation’ dynamics likely to mitigate the effect of QT – Decline in bond yield spread of India over US would typically occur when US bond yields are rising relatively fast while India yields are rising slowly or remain flat or decline (like in the current scenario). Typically, faster rise in US rates reflects quantitative tightening (QT) cycle by the US Fed while simultaneous decline in bond yields for India could at times reflect slowing growth outlook (an ideal condition for lower P/E multiples for Indian stocks). However, in the current environment, while QT is driving US bond yield higher, the earnings growth outlook for India is still reasonably robust with marginal downgrades and supported by the recovery in capex and credit cycle. The subdued 10-year bond yield is largely reflecting peak inflation for India and sharp decline in crude oil prices. Hence the favourable ‘growth-inflation’ dynamics for India will likely limit the impact on NIFTY50 P/E ratio due to the dip in bond yield spread

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