The bond market consists of the transaction of various debt instruments among investors. This can be corporate debt or government debt. The issuance of debt is called the “primary market.” The re-sale of this debt is called the “secondary market.” Parties raise debt for a variety of reasons, but primarily to fund growth through expansion. U.S. government bond market is among the largest and most liquid debt instruments to trade.
One of the most dangerous situations is when an investor attains a false sense of confidence. With the Federal Reserve enacting such an aggressive monetary policy stance, this has led to reduced levels of volatility and an uncanny calm in the financial markets.
Because the Federal Reserve has stepped into the financial markets with such a large level of support through their monetary policy program, this has led to bond prices that remain elevated and yields that are at very low levels. Not much has occurred over the past few years in terms of shocks to the system.
The danger occurs when investors believe this situation will remain in place forever. Nothing lasts forever and one should always prepare for the future.
So far, the net result from the monetary policy action by the Federal Reserve has been higher home prices, an increase in car sales, higher asset prices in general, such as stocks, and a general calm in the financial system.
What happens when the Federal Reserve starts to reduce its monetary policy stance? I think it will hit many sectors, but it will especially affect the bond market.
The President of the Federal Reserve Bank of New York, William Dudley, recently stated that the accommodative monetary policy stance needs to remain for the time being, due to continued weakness in employment growth. However, he did add that the Federal Reserve should begin adjusting monetary policy as the economy improves. (Source: Zumbrun, J., “Dudley Sees ‘Very Accommodative’ Policy on Weak Job Market,” Bloomberg, March 25, 2013.)
The U.S. economy still has not employed all those who lost their jobs … Read More
While many eyes are focusing on Europe and America when it comes to the next financial crisis, one sector that people aren’t focusing on is the bond market in Japan. Many investors might not realize it, but Japan might be the next financial ticking time bomb.
How does a financial crisis in the bond market affect the average person? On a basic level, the bond market prices move based on supply and demand, which affect interest rates. With greater demand in the bond market, this pushes up prices and lowers interest rates. A lower interest rate obviously helps prevent a financial crisis from occurring, as it takes less money to pay off the debt—much like a credit card interest rate being reduced.
Conversely, if investors are worried about their funds in the bond market, this will cause selling or a reduction in purchases, a decline in prices, and a rise in interest rates. For countries that have a large amount of debt, higher interest rates will cause a financial crisis, as the funds available to maintain that debt are limited and could run out.
Much like a person who racks up very high credit card debt, at some point the income from the person’s job is not enough to make the minimum payment, let alone pay down the principal. The end result is a financial crisis.
Japan has a massive debt-to-GDP (gross domestic product) level of 211%, much higher than America’s or even Greece’s debt burden. (Source: Trading Economics, last accessed January 7, 2013.)
Even though Japan’s 10-year bond interest rate is only 0.79%, a full 25.0% of government revenue … Read More
Markets were disappointed following the decision of both the Federal Reserve and European Central Bank (ECB) to inject monetary stimulus into their respective economies. And like the Fed, the ECB will look to the bond market for help as it considers another bond-buying program for Spain in hopes of driving down yields with the country facing a financial crisis.
Yet the problem is that Spain needs help now, as the 10-year Spanish bond traded at an unsustainable yield of 7.2% on Friday, which could force the country to seek a bailout to avoid a worsening of the financial crisis. Spain says it doesn’t need a bailout but a loan.
ECB chief Mario Draghi said the central bank would help Spain once it formally requests a bailout. Spain has already received about $130 billion to avert a financial crisis in its fragile banking system. My view is the ECB wants to see Spain put together a tough austerity program in exchange for a bailout, but Spain is trying to avoid this.
A tough austerity program would bind Spain’s spending (but isn’t this needed?). The country is declining in its economic strength. Its economy has fallen to 12th in the world in 2011, according to the International Monetary Fund (IMF). Previously, Spain’s economy was the ninth largest, but with its financial crisis it has since been surpassed by Russia, Canada, and India. Regardless, a collapse in Spain would be devastating.
The thought of tough austerity measures in Spain is causing civil unrest. Just like Greece, the country is facing a financial crisis, a second recession, and an unemployment rate of 25%. The … Read More
There is no question that the bond market has changed radically since the financial crisis hit in 2008. The Federal Reserve has since embarked on a campaign to buy U.S. Treasuries at a rate that is unprecedented.
Here is a statistic that illustrates the radical shift that has taken place in the bond market in 2008: In 2006, foreigners bought 82% of all U.S. Treasuries issued. Today, foreigners buy a total of 26% of all U.S. Treasuries issued, with the Federal Reserve absorbing what the market is not buying (source: MacroMavens).
Undeniably, fund and hedge fund managers are shifting money into U.S. Treasuries to protect themselves from the crisis in Europe, which is certainly fuelling demand for U.S. Treasuries in the bond market.
However, foreign central banks are the real big purchasers of most of the U.S. Treasuries issued. Before the financial crisis hit, foreign central banks bought U.S. Treasuries on a consistent basis in the bond market. Since the financial crisis hit, central banks have had to put out their own fires at home.
China was the largest purchaser of U.S. Treasuries, but the country now has a slowing economy it needs to deal with. Reports of empty cities and companies saddled with the debt from those empty cities, which are not producing any revenue, illustrate how China needs the money to handle its own problems at home.
China has also made clear its intention of owning hard assets over any other currency. China has become a huge buyer of oil and gold in recent years.
Japan was the second largest buyer of U.S. Treasuries before the financial crisis … Read More
The bond market, according to Thomson Reuters, experienced a global falloff in debt issuance by 39% in the second quarter of 2012 when compared to the first quarter of 2012. For the first six months of 2012, when compared to the first six months of 2011, the bond market saw a decline in debt issuance of 11%.
The numbers were pushed down by Europe—especially in the heart of the crisis: southern European countries—where the bond market experienced a quarter-over-quarter 60% drop of debt issuance this year.
Couple this with the fact that mergers and acquisitions have fallen by 24% in the first six months of 2012 when compared to the first six months of 2011. According to Mergermarket, 2012 is shaping up to be the worst year for mergers and acquisitions since 2004.
With the bond market slowing and fees from mergers and acquisitions falling, more big banks have cut staff around the world. Many big banks are also looking to alter their divisions permanently, since it looks like the bond market is not going to return to levels seen before the financial crisis hit in 2008.
The eurozone crisis coupled with the slowdown in Asia, which was started by the economic slowdown in China and India, along with the U.S.’s inability to pick up any steam concerning economic growth has left corporations very hesitant to make any investments. Without corporations driving the bond market, the big banks don’t make fees in equity issuance, mergers and acquisitions, and fees from debt issuance.
It is a vicious cycle that adds more proof to the notion that the global economy is slowing … Read More