The spread between the Sensex’s earnings yield and the US 10-year Treasury yield has turned negative and is now at its lowest level in 14 months.
The US 10-year Treasury yield has risen by 102 basis points (bps), or about a quarter, since the end of September last year, from 4.15 per cent to 5.17 per cent on Friday.
Over the same period, the Sensex’s earnings yield has risen by only 60 bps, from 4.5 per cent to 5.1 per cent on Friday. One bps is a hundredth of a percentage point.
The narrowing gap makes Indian equities less attractive to the relatively risk-free returns available on US government bonds and other developed-market assets.
Over the past 20 years, the spread between the Sensex’s earnings yield and the US 10-year Treasury yield has been as wide as 600 bps, against an average of about 190 bps. Analysts say the current low spread is one of the factors behind the recent selling by FPIs on Dalal Street, prompting them to seek higher earnings yields, or lower equity valuations, to compensate for US bond yields.
“Higher yields on US Treasury bonds reduce the incentive for FPIs to invest in risk assets such as Indian equities. They will now ask for higher earnings yields, or lower equity valuations, to compensate for higher yields on risk-free assets in developed markets,” said Dhananjay Sinha, co-head of research and equity strategy at Systematix Institutional Equity. “If they don’t get it, they will be reluctant to invest, as we have seen in recent months.”
Data from the National Securities Depository shows that FPIs have withdrawn $1.23 billion from Indian equities in September so far. Their total withdrawals over the past 12 months have reached $26.7 billion.
The Sensex, meanwhile, has fallen about 8 per cent over the same period, from 80,267.6 at the end of September last year to 73,895.7 on Friday.
Higher US yields can also put pressure on the rupee, adding another headwind for Indian equities.
“Higher yields in the US will translate into a stronger dollar and a weaker rupee. A weaker currency, in turn, will weigh on investor sentiment, as we have seen in the past,” said G Chokkalingam, founder and chief executive of Equinomics Research.
The earnings yield is the inverse of a security’s price-to-earnings multiple. It indicates the potential return to an investor if a company distributes all of its annual net profit as dividends. In practice, companies generally distribute only part of their profits and retain the rest for investment or to build cash reserves.
The Sensex’s trailing 12-month price-to-earnings (P/E) multiple is now at its lowest level since July 2016. The only major exception was the Covid-19-triggered selloff, when valuations briefly fell to 18.8 times at the end of April 2020 before recovering sharply.
The US 10-year yield, by contrast, is at its highest level since April 2002. The Sensex’s underlying earnings yield is also at its highest in more than a decade, apart from the spike during the Covid-19-triggered selloff in April 2020.
Economists expect bond yields in the US and other developed markets to remain elevated. “The US Federal Reserve has indicated at least two more rate hikes as it fights higher inflation. This signals a further hardening of bond yields in the world’s biggest economy, and the situation is similar in other developed markets,” said Madan Sabnavis, chief economist at Bank of Baroda.
Historically, US bond yields have had a strong negative correlation with the Sensex’s trailing price-to-earnings multiple. In simple terms, higher bond yields tend to coincide with lower equity valuations, and vice versa.
The relationship has been particularly strong over the past five years. Global bond yields fell sharply in 2020 before rising steadily from 2021 onwards. The correlation between the US 10-year Treasury yield and the Sensex trailing P/E has been as much as -0.85 since January 2021.
The numbers illustrate the shift: The Sensex’s trailing 12-month P/E has fallen nearly 42 per cent from a record 33.5 times at the end of December 2025 to 19.6 times on Friday. Over the same period, the US 10-year yield has risen 426 bps, from 0.91 per cent to 5.16 per cent.
By contrast, the rise in the Sensex’s P/E between 2012 and 2020 was accompanied by a decline in US bond yields and lower yields across other developed markets.
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