Global Bonds Sentiment

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Jul 16 2015 at 5:00 PM Updated Jul 16 2015 at 5:29 PM

BlackRock and Janet Yellen driving bond bus “over a cliff”: Carl Icahn


Carl Icahn, chairman, Icahn Enterprises and Laurence D Fink, founder, chairman and chief executive officer, BlackRock CNBC


by John Kehoe
When hedge fund tsar Carl Icahn came face-to-face with the chief executive of the world's largest investment manager in New York on Wednesday, he accused BlackRock's Larry Fink of running "an extremely dangerous company".

To illustrate the point, Icahn spoke of an imaginary cartoon featuring a bus full of boozy, partying bond investors, blissfully unaware of the trouble they were hurtling towards.

"We are going over to a cliff," Icahn told the audience of financiers.

"And you know who's pushing that thing? It's Larry Fink and Janet Yellen."

Fink, evidently annoyed as the spectators burst into laughter, told Icahn he was "dead wrong" about the $US4.7 trillion asset manager.

Icahn, one of America's most famous activist investors, who developed a reputation as a ruthless corporate raider in the 1980s, believes there is a huge bubble brewing in the $US3.7 trillion US corporate bond market that will "blow up". He is particularly worried about the exchange traded fund (ETF) corner of the market.

Icahn claims that BlackRock and US Federal Reserve chairwoman Janet Yellen are largely to blame.

The Fed's ultra loose monetary policy, including a $US4 trillion bond buying program that ended last year, combined with BlackRock's dominant involvement in the fixed income market, have pushed the prices of riskier so-called high yield bonds to around record highs.

Major companies have been selling the "junk bonds" in droves, to take advantage of the Fed's ultra low interest rates and insatiable demand from yield-hungry investors prepared to take on more risk in chase of a decent return in the low-rate environment.

Layered underneath the $US3.7 trillion US corporate bond market is the rapidly evolving $US1.5 trillion exchange traded market, which BlackRock's funds are major players in. Icahn thinks the ETFs are "overpriced" and "illiquid".

LET INTEREST RATES RISE, ICAHN SAYS

Icahn, 79, says the Fed and BlackRock have been refusing to "touch the brakes", a metaphor for allowing rates to rise. Yellen did signal earlier on Wednesday at a hearing on Capitol Hill in Washington that she plans to raise rates for the first time in a decade later this year.

Evidently, Icahn, worth an estimated $US23 billon according to Forbes, thinks rates have been too low for too long, building risks into the fixed income markets.

His fear is that as interest rates belatedly rise and bond prices fall, skittish investors will head for the exits in concert and cause a crash in the bond market.

Icahn predicts the high yield market, especially in ETFs, will prove illiquid, meaning there is "nobody to buy this stuff".

Reserve Bank of Australia assistant governor Guy Debelle last October warned of a possible "violent" sell-off in fixed income due to a potential lack of liquidity in a falling market.

ETFs are securities that track an underlying index, such as a bond, commodity or basket of assets.

Potentially extenuating the problem that Icahn envisages is the withdrawal of investment banks as intermediary buyers and sellers in the bond market.

While Fink acknowledged the "buffer" has been removed due to strict new regulations banning banks from proprietary trading, he argued that ETFs create more transparency in the market, "especially high-yield".

ETFs are traded continuously on exchanges, unlike mutual funds and some of the underlying securities which sometimes only change hands in the more opaque over the counter market.

BOND MARKET NOT IN IMMINENT DANGER: FINK

Fink's more upbeat assessment of the bond market is partly because he says demand for bonds will stay strong.

As baby boomers retire, they will demand more yielding defensive assets like bonds. He added that rising rates would also boost demand.

Fink, who managed to keep his composure and appeared not to take the professional attack personally, said Yellen will not be able to raise rates too quickly because of the dampening effect of the soaring US dollar and loose monetary policy by central banks around the world.

"Carl, once again, you are a good investor, but you are wrong again, you are just dead wrong," Fink said at the CNBC Institutional Investor Delivering Alpha Conference.

It's not the first time the pair have sparred publicly.

Fink has previously criticised Icahn and other activist investors for pressuring companies into short-term actions, such as share buybacks, higher dividends and spinoffs, at the expense of long term investment.

"It could be one of the reasons we have a below-trend line economy," Fink said on Wednesday.

Despite their differences, Fink and Icahn agreed there were good and bad activists, with the BlackRock chief revealing the firm had voted in favour of activists on shareholder resolutions on 45 per cent of occasions.

To settle their bond dispute, Fink offered to take Icahn to lunch to give him a more in-depth tutorial.

"I'll pay," Fink said. Icahn signalled he would take up Fink's offer.

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Don't let myths destroy your interest in bonds
Jeffrey Johnson
1050 words
29 Jul 2015
The Australian Financial Review
AFNR
English

Portfolio Just because the US central bank is on the verge of raising interest rates does not mean bonds are on the brink of collapse.

Terms such as "bond bubble" suggest to many investors that they need to question the role of fixed income in a portfolio and that perhaps the income-generating and defensive attributes of bonds no longer apply.

As if markets didn't present enough challenges, investors seeking income and exposure to defensive assets face a dilemma. How, or even why, should bonds be held following a multi-year period of strong performance, anticipating a more difficult period ahead?

For a variety of reasons the environment for bonds could become more challenging, but several oft-cited myths may be leading investors to ignore this important asset class.

Myth 1: Interest rates are headed

higher and prices on bonds are

headed lower

This is probably only partially true. Yes, most signs point to the US Federal Reserve lifting its target rate as early as September on the back of an economy that is finally, post-GFC, strong enough to withstand the removal of aggressive monetary stimulus. However, the Fed may not raise rates as quickly or to as high a level as in previous cycles.

It is also important to keep in mind that the Fed only controls short-term interest rates; higher long-term interest rates tend to be a result of strong growth and/or rising inflation expectations - neither of which we are seeing at present.

But the US may be nearly alone in its move upward. Here in Australia the last two interest rate moves made by the RBA have been cuts, with a bias towards more of the same as the economy continues to require stimulus to cure the hangover of the mining boom.

In Europe and Japan, policymakers are combating environments generally characterised by low growth, high unemployment, high debt and on-again-off-again deflationary pressures, meaning they may be hard pressed to raise interest rates this decade. The bottom line is that: 1) there is a divergent global picture with rates headed higher in certain regions, stable in some, and lower in others, and 2) short-term and long-term rates may react in different ways, meaning investors should focus less on interest rate predictions and more on the broader role bonds play in a portfolio.

Myth 2: Higher interest rates are

a bad thing for bond investors

As noted, higher rates may not occur as quickly or dramatically as some expect, but for argument's sake let's assume for a moment that rates do head higher (and after more than 20 years of falling interest rates this is bound to occur eventually).

But higher interest rates mean that future interest income and proceeds from maturing bonds are reinvested at higher yields. And higher yields attract buyers seeking higher income to the market, thus providing some support to bond prices.

Of course, there can be some short-term pain as bond prices fall in response to higher yields, but the picture is not necessarily as dark as some would have us believe. A good rule of thumb is that a bond fund's duration can be used to approximate its interest rate sensitivity. The Bloomberg AusBond Composite, for example, has a duration of 4.6 years, meaning that a 1 per cent rise in yields across the yield curve would likely lead to a price decline of about 4.6 per cent. International treasuries and global corporate bonds (duration of 7.1 and 6 years, respectively) have somewhat higher interest rate sensitivity, but are also highly diversified and, as noted earlier, divergent interest rate environments.

The duration can also be used to approximate the amount of time it takes for the higher income generated from higher yields to offset the initial price decline. For patient investors in accumulation and for investors with a multi-year need for income in retirement, higher interest rates can be a good thing.

Myth 3: A low interest rate

environment diminishes bonds'

role in a portfolio

Interest rates are low by historical standards, but so is inflation.

Over the next 10 years a reasonable return expectation for a globally diversified bond portfolio is around 3 to 3.5 per cent, but with inflation anticipated to be around 2 per cent, bonds are expected to fulfil their role as a generator of real returns.

Regardless of the outlook for returns, bonds provide diversification benefits to riskier asset classes such as equities: while they can experience periods of volatility, it generally pales in comparison to volatility experienced by equities, and high-quality bonds tend to provide considerable downside protection during equity market corrections and bear markets.

To be clear, an equity market correction or bear market is not Vanguard's central forecast at this point, but with valuations on equities globally generally on the high side, lower returns than those experienced over the last several years can be expected.

Investors should not rule out an increase in volatility - as we have seen recently - following an extended period of very low volatility.

Are bonds without risk? Of course not. Many segments of the bond market today - particularly higher-risk and lower-rated corporate bonds or "high-yield" bonds - offer very little compensation in the form of additional yield for their greater risk, making it an especially dangerous time for investors to "reach for yield".

Bond markets are unlikely to repeat the 7-plus per cent annualised returns of the past 15 years. And the risk exists that policymakers, with no historical playbook, will struggle to exit from exceptionally aggressive and accommodative policy measures.

The key for investors is to maintain reasonable return expectations, remain disciplined in the face of uncertainty about the interest rate outlook, and to remember that a rising interest rate environment is ultimately a good thing for investors focused on income and defence, despite the potential price declines that could be experienced in the short-to-intermediate term.

A globally diversified fund mitigates the risks and preserves the benefits of the asset class, which continues to serve a key role for investors in an uncertain, challenging and potentially more volatile investment environment.


Fairfax Media Management Pty Limited

Document AFNR000020150728eb7t0002n

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Aussie bonds: love affair cools as low-rate era fades
VERA SPROTHEN, JAMES GLYNN THE AUSTRALIAN AUGUST 05, 2015 12:00AM

Fading trade Source: TheAustralian

Touching down recently in Tokyo, Australian bond-market strategist Martin Whetton looked forward to amicable talks with groups of Japanese investors.

Halfway through his meetings, Mr Whetton, who works for ANZ, realised that his Japanese clients — among the most prolific buyers of Australian government debt — were turning frosty on the trade.

Several spoke of the darkening outlook for resource-rich Australia’s economy, citing a plunge in commodity prices, escalating unemployment, and the risk of a property bust. Many were alarmed, too, by recent big falls in the Australian dollar, already ­generating significant losses on their largely unhedged bond ­investments. “They were more downbeat on Australia than I’ve ever experienced,” said Mr ­Whetton. “I was surprised. They used to love us.”

The strategist said he had ­detected a similar unease among investors from the US, Singapore and Hong Kong. It wasn’t always this way. Shortly after the financial crisis, foreign investors began pouring money into Australian bonds, seeing the nation’s strengthening economy as a bulwark against the global slowdown. Its close trade ties with industrialising China, whose rising demand for raw materials was driving up commodity prices, made it seem a safe bet in a low-growth environment. What’s more, many investors saw Australia’s high-yielding bonds as an attractive alternative to ultra-low interest rates everywhere else, while its ascending currency made investing in the country’s assets even more ­appealing.

Overseas demand for the ­nation’s bonds drove foreign ownership of Australian government debt to record highs in 2012, as some of the world’s most powerful central banks and sovereign wealth funds weighed into the ­nation’s AAA-rated paper.

The love affair is now cooling as investors sense the end of the global low-rate era. The US Federal Reserve is expected to raise rates from near zero as soon as next month, a move likely to ripple through global bond markets as US markets begin to suck up more of the world’s money.

“The fervent search for yield (in Australia) is done,” said Mr Whetton, whose view is supported by government data showing foreign investors now own just over two-thirds of Australian government debt. That compares with nearly 80 per cent as recently as three years ago.

Things may worsen if the dollar’s slide continues to reflect Australia’s weakening economy at the end of a decade-long commodity boom. “The tide may be starting to turn,” said Su-lin Ong, head of Australian research at RBC Capital Markets. “Australia may need to fight a little harder for that bond flow in the years ahead, and investors are likely to demand a greater premium.”

The currency has shed about 23 per cent against the US dollar since the middle of last year, and more than 10 per cent against the yen over the past eight months. Some analysts expect a further drop of as much as 10 per cent against the US dollar in the coming year as the Fed raises rates, just as Australian policy makers consider lowering further.

“A weaker Aussie dollar potentially mitigates the attraction,” said Steve Miller, Australian head of fixed income at BlackRock. “On a hedged basis, maybe there’s some interest in Aussie bonds, but on an unhedged basis it’s a bit more problematic.”

Mr Miller and others think the Aussie could fall to as low as US65c by mid-next year from about US73c now.

Mr Whetton said he had already noticed a slowdown in Japanese demand for Aussie bonds, while some of his US clients had begun cutting back their exposure.

But not everyone is running scared. Indeed, some overseas-based bond investors plan to hold onto Australian paper precisely because the economy is looking so weak, betting the central bank will be forced to take rates lower than the current 2 per cent record low, and thus boost the value of their existing holdings. Australian interest rates have “nowhere to go other than down”, said Robert Mead, a Sydney-based fixed-income manager at Pacific Investment Management Co. “Rather than Aussie bonds looking on the nose, we’d say that on a relative basis they look pretty ­attractive.”

For others, Australia remains a relatively safe place to invest at a time when the risk of global economic shocks is still present, as indicated by the Greek debt flare-up.

“We’re concerned about different trouble spots in the world, and Australian bonds generally rally during periods of risk aversion,” said Yvette Klevan, a New Yorkbased portfolio manager at Lazard Asset Management.

Still, the dwindling interest in new Australian bonds comes at a bad time for the government, which has ramped up its bond issuance to help plug the country’s budget deficit. Two weeks ago, Standard & Poor’s amplified its warnings over the sustainability of Australia’s AAA rating as weakening commodity prices make it harder for the government to balance its books.

Eric Stein, a Boston-based portfolio manager at Eaton Vance, said he no longer held Australian government bonds and saw no reason to buy them. “The Australian economy is slowing dramatically and the Australian dollar certainly could go below US70c if the Fed tightens in September,” he said. He has switched to a simpler trade: short the Aussie dollar.

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Aug 13 2015 at 9:08 AM Updated Aug 13 2015 at 4:11 PM
Why you must watch liquidity risk, especially in bonds

Being able to buy and sell a security should not be taken for granted.


Liquidity risk should always be a key factor for investors when they are constructing portfolios, but when it comes to retail investors and corporate bonds it can be difficult. Jessica Shapiro
Philip Baker

When it comes to investing, "less wrong" hopefully ends up meaning "more rich". That's just one of the many golden rules you sometimes hear.

Not losing money is another. While it never pays to become too cautious too early, at least that way you leave money on the table for others.

However, there's never much emphasis on being able to buy and sell the asset that drives the return. Liquidity is often taken for granted and the real dilemma is always seen as a question of what to buy, followed by when is the best time to buy. But it shouldn't be that way.

This probably applies more to the bond market than the sharemarket, because shares trade on an exchange and you can see the prices.

But investors in the retail bond market, in particular the corporate bond market, are hostage to the broker they buy the bonds from in the first place. Bond prices are taken from a broker's daily sheet but when investors go to deal the next day they can move substantially, giving grief to all concerned.

There is never quite the same problem about "getting set" in the corporate bond market. Primary issues are dealt in an orderly manner, everyone knows the pre-marketing price range and final pricing and, if it's a popular deal, investors might get scaled back.

It's the secondary market that is the problem. Often the price offered on the day can differ to the one on the price sheet, even after taking into account any moves in the bond market.

ROLLER-COASTER RIDE

There has been a lot of talk lately about a lack of liquidity in global bond markets. This really all goes back to October 2013, when the yield on the benchmark 10-year US government bond – the benchmark bond in the safest market of all, and the bond that all other bonds are priced off – fell 33 basis points in quick-smart time.

It then spiked back to 2.13 per cent, up from 1.86 per cent. The move was so extreme it was described as, mathematically at least, a rise that could only be expected to happen once every 1.6 billon years.

An investigation into the move didn't reveal any great reasons behind the roller-coaster ride, and the worrywarts have been warning about liquidity in global bond markets ever since.

The concern is that, because yields are so low and with so many investors now exposed to bonds since the global financial crisis, it's going to be very difficult to get out when the time is right to do so.

Liquidity risk should always be a key factor for investors when they are constructing portfolios, but when it comes to retail investors and corporate bonds it can be difficult.

And bonds are meant to be buy-and-hold investments, although since the GFC investors tend to be more active.

For professional investors, liquidity management is a dynamic and vital part of the process that they perform on a daily, and often intraday, basis.

PIMCO's new boss, Doug Hodge, said in a note to clients that he's not surprised the subject of bond market liquidity has come under increasing focus because banks in the United States are now required to hold more capital to make them safer after the GFC.

For that reason they don't tend to hold much inventory of bonds and so secondary trading in them is harder. Or it can take longer to execute or get out of a deal.

"Liquidity risk is part of the investment risk that investors knowingly take on when they invest their assets in the capital markets to pursue their investment objectives," Hodge says.

He points out investors should not confuse investment risk with systemic risk. "While price moves may be more disjointed – and prices may have to decline more significantly for a market price to be established – price declines are not the same as the system failing."

The other point is that, if you truly are a long-term investor, these wild price swings can deliver opportunities but they always seem to happen when you are trying to sell and the price falls.

Buying never seems to be a big deal as investors normally get allocated bonds when they are a primary issue into the marketplace.

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• OPINION
   
  
  
•  Aug 31 2015 at 12:00 AM 
   
  
  
• Updated 1 hr ago
  

US bond market points to more volatility ahead

[img=620x0]http://www.afr.com/content/dam/images/g/j/8/p/r/z/image.related.afrArticleLead.620x350.gjb3qh.png/1440930040719.jpg[/img]After tumbling below 2 per cent on Monday, bond yields then spiked, with US bonds suffering their biggest weekly price drop in two months. Reuters
[Image: 1435478719294.png]

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by Karen Maley
After last week's violent gyrations, investors could be excused for hoping that global markets might settle down to a period of tranquillity. Unfortunately, that's not the signal emanating from the world's most liquid market – the multitrillion-dollar US bond market.
Indeed, one of the most surprising aspects of last week's market turmoil was investors' marked refusal to treat US bonds as a "safe haven". Usually, a bout of sharemarket volatility causes investors seek refuge in bonds, which has the effect of pushing up bond prices and sending bond yields sharply lower.
But last week a different pattern emerged. After tumbling below 2 per cent on Monday, bond yields then spiked, with US bonds suffering their biggest weekly price drop in two months.
As a result, despite the huge volatility in global markets, the 10-year US bond yield finished the week at 2.2 per cent, a big increase from 2.05 per cent a week earlier.

Some analysts believe that Chinese selling is responsible for the US bond market's aberrant behaviour. They argue that the Chinese authorities have been selling some of the country's massive $US3.5 trillion ($4.8 trillion) in foreign exchange reserves and using the proceeds to buy yuan in order to keep the currency from falling too sharply.
In the past, when China was routinely running huge trade surpluses, the Chinese central bank kept a lid on the local currency by printing yuan and using the money to buy US dollars from Chinese exporters. These US dollars were then recycled into foreign assets.
Although China does not disclose the composition of its foreign exchange reserves, it's estimated that around two-thirds of China's reserves are invested in US-denominated assets, mostly US bonds.
But now the situation is reversed. The Chinese currency has been coming under pressure as more and more capital is flowing out of the country. In the past year alone, it's estimated that around $US500 billion flowed out of China.


TOO DIFFICULT
Because large capital outflows put downward pressure on the currency, Beijing has been forced to keep buying yuan to support its currency, which meant that it was eating into its foreign currency reserves.
Eventually Beijing decided that it was too difficult – and expensive – trying to maintain the yuan's peg to the rising US dollar. Earlier this month, Beijing decided to relax its grip on the currency, allowing the yuan to devalue.
But Beijing was fearful that its trading partners might decide to retaliate by pushing their currencies lower, which would set off a currency war. As a result, it has intervened heavily in foreign currency markets in the past fortnight, spending about $US150 billion to prop up the yuan. In order to buy yuan, Beijing has had to sell other assets, including US bonds.

From the Chinese perspective, selling US bonds has been a positive, because it has cleared the way for the People's Bank of China to provide much needed monetary stimulus to the Chinese economy, without fearing too steep a drop in the currency.  
But Chinese selling represents a huge shift for the US bond market.
After all, since the financial crisis, the US central bank has spent trillions of dollars buying bonds in an effort to boost economic activity by pushing long-term borrowing costs lower. The US central bank's third bond-buying program, known as "quantitative easing" or QE3, only ended last October.
Some analysts warn that the pressure on US bond markets is likely to intensify as China tries to counteract the effect of heavier capital outflows. Analysts estimate US bond yields could rise by as much as 40 basis points if China sold $US200 billion worth of bonds.

Even worse, many emerging countries are seeing their currencies come under pressure, in the wake of China's decision to devalue the yuan. As a result, they've been forced to sell foreign assets – including US bonds – in an effort to prop up their currencies and restore calm to markets.
The risk is that this selling pressure pushes US bond yields sharply higher at a time when deflationary pressures are on the rise from the falling Chinese currency.
Faced with a jump in real borrowing costs at a time when their profit margins are already coming under intense pressure, US firms are likely to shelve their hiring and capital spending plans, putting the US recovery in jeopardy.

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• Sep 19 2015 at 12:15 AM 
   
  
  
•  Updated Sep 19 2015 at 12:15 AM 
  

Bond markets face liquidity challenges

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NaN of
[img=620x0]http://www.afr.com/content/dam/images/g/j/o/2/p/u/image.related.afrArticleLead.620x350.gjm5cq.png/1442547285460.jpg[/img]Rerserve Bank assistant governor Guy Debelle says there has been a shift in market share from those who provide immediate and continuous liquidity and have the ability to warehouse risk to those who do the same, but don't have the capacity to warehouse risk. Daniel Munoz
[Image: 1435478719294.png]

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by Karen Maley
Investors enjoyed some respite last week from the anxiety that has hung over markets in the past few months, but some analysts warn that it's only a matter of time before the lack of liquidity in global markets triggers a fresh round of turbulence.
Analysts warn that there is a lack of liquidity in global markets despite the aggressive bond-buying programs that have been launched by the European Central Bank and the Bank of Japan.
The problem is that emerging markets are battling massive capital outflows as risk-averse foreign investors withdraw their funds. In many cases, this has forced central banks to intervene in markets to stop their currencies from falling too sharply.
To do this, emerging markets have had to sell down their foreign reserves, which are typically held in high-quality assets such as US or European bonds. These bond sales tend to push down bond prices, causing long-term interest rates to rise (bond yields rise as prices fall).

The fear is that these sales of US and European bonds by central banks in emerging markets – which some analysts are calling "quantitative tightening" – could swamp the effects of the bond-buying programs that are being run by the European Central Bank and the Bank of Japan. Together these two central banks are buying about $US130 billion ($181 billion) of bonds each month.
Indeed, some believe that the lack of liquidity was a big reason for the turmoil in global financial markets in August.
INTERVENED HEAVILY
China's foreign exchange reserves plunged by almost $US94 billion in August as Beijing intervened heavily to halt a slide in the yuan. At the same time, central banks in other emerging markets spent an estimated $70 billion in the month trying to defend their currencies.


Together, this $US160 billion or so in bond sales in Europe and the United States eclipsed the bond purchases by the ECB and the Bank of Japan, and was probably a factor in pushing up global bond yields, and pushing down the price of risky assets such as shares.
The big question for investors is whether emerging-market central banks will be forced to continue to intervene as heavily to prop up their currencies.
If China and other emerging markets wind down their intervention and stop selling US and European bonds as heavily, the drain on global liquidity will ease.
Unfortunately, emerging markets are still suffering from heavy capital outflows, leaving central banks in these countries with little choice but to continue running down their foreign reserves to defend their currencies.

Deprived of the plentiful supply of liquidity that they've enjoyed since the financial crisis (central banks have injected about $US10 trillion in funds through bond-buying programs in the past five years alone), global markets are likely to struggle to retain their lofty levels, particularly if US and European bond yields start to climb higher.
Apart from the problems arising from emerging-market bond sales, there's a more general problem with liquidity levels in the bond markets around the world.
SOMETHING CURIOUS HAPPENING
As Guy Debelle, the Reserve Bank of Australia's assistant governor (financial markets), noted in a speech in Sydney this week, something curious is happening in bond markets. On one hand it's very easy for investors to offload small parcels of bonds for very close to the prevailing market price. But, he says, investors' ability to sell large parcels of bonds is "worse than it's been for quite some time".

Debelle argues that this is because the market has changed in response to technological and regulatory changes, as well as the shift in the behavioural patterns of big institutions.
The major technological change is the increased prevalence of electronic trading in global bond markets. In the Australian bond market, electronic trading accounts for about one-third of the trade in Australian government bonds. In the United States, it accounts for more than a half.
Electronic trading has also encouraged the emergence of high-frequency trading firms, which are providing liquidity for small trades, but which are often unable to trade in large amounts because of balance sheet constraints.
As a result, Debelle argues there has been a shift in market share "from those who provide immediate and continuous liquidity and have the ability to warehouse risk to those who do the same, but don't have the capacity to warehouse risk".
At the same time, regulatory changes have increased the cost to banks of providing liquidity in the bond market. As a result, some players have withdrawn from the market, while others have scaled back their activity. Even for those banks that have remained active in the market, higher costs mean their bond desks hold less stock than they once did.
REDUCED CAPACITY
But not only are the banks providing less liquidity, they also have a reduced capacity to warehouse risk. In the past, banks were among the first to step into the market and buy bonds when they saw prices had fallen too far. But Debelle says "as a result of regulatory changes, as well as their own risk tolerances, they are less willing and able to do this today".
The problem is that fund managers are often constrained by their mandates from jumping into markets and buying assets such as bonds when their prices have dropped sharply.
If neither banks nor fund managers are willing or able to buy bonds when their prices have dropped too far, Debelle warns that "prices will move by larger amounts and remain away from equilibrium values for longer. Volatility will be higher."
As volatility spikes, he says, "overshooting will be more likely and that can have longlasting and more deleterious consequences."

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Bond market growing bigger and more fragile

• COLIN BARR
  
• THE WALL STREET JOURNAL
  
• SEPTEMBER 22, 2015 12:00AM
  

[Image: 528981-28b18600-6035-11e5-998f-5d4478d7f37a.jpg]
US bond market. Source: TheAustralian
[b]Stocks rise and fall, but bonds are starting to make people anxious no matter what they do.[/b]
The US bond market is among the biggest financial markets in the world, with $US39.5 trillion ($55 trillion) outstanding at mid-2015, according to the Securities Industry and Financial Markets Association. That is equivalent to 1½ US sharemarkets and nearly twice the aggregate size of the five largest foreign stock exchanges (in Japan, China and Europe), says the World Federation of Exchanges. Foreign bond markets have boomed as well.
Surveying the global bond market of 2015 can be an intimidating exercise. Long associated with safety and predictability, bonds appear vulnerable as never before to price reversals and trading disruptions that could spill over and threaten financing for businesses and individuals.
A new bond market has taken shape since the global financial crisis. It is a world of low interest rates that fuelled huge debt issuance and investor risk-taking, tighter regulations that are constraining banks, and the rise of asset managers and fast-trading firms that are changing how bonds are bought and sold.
The market is under scrutiny because the Federal Reserve is preparing to raise interest rates for the first time in nine years, at a time when the global economy is limping and debt ratios of countries around the world are higher than they were heading into the financial crisis.
In the US, household, corporate and government debt amounted to 239 per cent of gross domestic product in 2014, the Bank for International Settlements said, compared with 218 per cent in 2007.
The US isn’t alone. Dollar credit to non-bank borrowers outside the US hit $US9.6 trillion this northern spring, the BIS said, up 50 per cent from 2009. Repaying those loans and bonds will become costlier in local-currency terms should the US dollar rise, as it often does, when the Fed goes ahead with tightening, potentially stressing large borrowers such as emerging-market companies.
Domestically, the rise of large bond funds has created new risks. As the funds have grown, so has cross-ownership of the same bonds, increasing the likelihood of contagion if one manager starts selling, the International Monetary Fund says. Regulators worry that many investors may not know what is in their funds. A market downswing could lead to rising redemptions of fund shares, prompting funds to sell assets to raise cash and amplifying selling pressure across the market.
Since 2007, $US1.5 trillion has gone into US bond mutual and exchange-traded funds holding assets from government bonds to corporates and municipal debt, according to the Investment Company Institute. That compares with $US829 billion into comparable stock funds.
Bond mutual and exchange-traded funds now own 17 per cent of all corporate bonds, up from 9 per cent in 2008, according to the ICI. In periods of market stress, more concentrated mutual fund ownership tends to mean larger price drops, the IMF said last year.
Annual US corporate high-yield bond issuance never exceeded $US147bn until 2010, according to Sifma data going back to 1996, but has more than doubled that figure in each of the past three years. Defaults remain low, but portfolio managers say judging when they might rise is difficult with interest rates still near zero.
The issue isn’t that the bond market is in a “bubble” that is about to be popped. The Fed’s decision last week to hold interest rates steady was another reminder yields will stay low in the years ahead.
At the same time, events such as the 2013 “taper tantrum” and the “flash crash” in the US Treasury market last October underscore the sense among many analysts and traders that the bond market is alarmingly fragile and increasingly subject to volatility more often associated with stocks and commodities. Consider the trading this northern spring in the 10-year German bund — along with US Treasuries, one of the world’s most trusted securities. On April 17, the yield on the bund plunged to a highest low of 0.05 per cent. Three weeks later, it spiked to 0.786 per cent, without a major news event or apparent broad shift in investor sentiment. The bund, for this brief period, was a momentum trade, like the internet stocks of a generation ago.

[greengiraffe]

Old ginger still hotter... my client once told me that financial mkts are prone to 10 yr cycle and years around 7s are jinxed... it ain't over till the fat lady sings... akang datang...


No one knows exactly why, but unusually large number of market upheavals have occurred in the months of September and October, including the 1929 Wall Street crash (share prices began to decline in September and early October, but it wasn't until October 29 that year that Black Tuesday hit), and the 1987 share market collapse (again, the US share market peaked in August, but Black Monday – which saw the US share market fall by almost 23 per cent– took place on October 19).

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But these aren't the only calamities. The $US3.7 billion ($5.4 billion) bailout of the highly leveraged hedge fund Long-term Capital Management (which, in retrospect, looks like a small dress rehearsal for the financial crisis) took place in September 1998. A decade later, US investment bank Lehman Brothers filed for bankruptcy (15 September, 2008) setting off a panic that threatened the entire global financial system.

• Sep 25 2015 at 12:51 PM 
   
  
  
•  Updated Sep 25 2015 at 3:03 PM 
  

Investors head for US Treasury bonds amid jitters over global economy

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[img=620x0]http://www.afr.com/content/dam/images/z/v/z/0/3/image.related.afrArticleLead.620x350.gjtebe.png/1443157407572.jpg[/img]Trading in US government bonds has lifted. Greg Newington
by Karen Maley
Maybe it's just that time of year.
Global share markets have slumped in the past week, in the wake of the US Federal Reserve's decision to keep its key interest rate close to zero. Rather than seeing this as a sign that the US central bank is determined to keep the monetary stimulus flowing in order to boost the US economy, investors saw the decision as a sign that the outlook for global growth is even worse than they thought.
But investors may also be worried that we're now approaching that perilous time of year when markets are particularly prone to major accidents.
No one knows exactly why, but unusually large number of market upheavals have occurred in the months of September and October, including the 1929 Wall Street crash (share prices began to decline in September and early October, but it wasn't until October 29 that year that Black Tuesday hit), and the 1987 share market collapse (again, the US share market peaked in August, but Black Monday – which saw the US share market fall by almost 23 per cent– took place on October 19).
[img=620x0]http://www.afr.com/content/dam/images/g/j/v/1/o/z/image.imgtype.afrArticleInline.620x0.png/1443157085608.png[/img]
But these aren't the only calamities. The $US3.7 billion ($5.4 billion) bailout of the highly leveraged hedge fund Long-term Capital Management (which, in retrospect, looks like a small dress rehearsal for the financial crisis) took place in September 1998. A decade later, US investment bank Lehman Brothers filed for bankruptcy (15 September, 2008) setting off a panic that threatened the entire global financial system.
As we head into this perilous period this year, there are three main worries weighing on investors minds: slowing growth in China, the potential for another emerging market crisis, and the threat of deflation.
For much of this year, signs that the Chinese economy is braking sharply have unsettled global markets.
But investors were disturbed when the US central bank highlighted the headwinds facing the US economy as a result of the slowdown in China and other emerging countries.


In its latest policy statement, the Fed said that "recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."
As if to emphasise the weakness in the world's second-largest economy, the preliminary Caixin Manufacturing Purchasing Managers' Index, an initial measure of Chinese factory activity, fell to a 6½-year low in September. The flash Caixin manufacturing PMI fell to 47 in September, down from 47.3 in August (a reading below 50 indicates contraction).
The index, which has been in contraction territory since February, highlights the difficulties that Chinese manufacturers face, as domestic demand is too weak to pick up the slack from the collapse in export orders.
The latest figures are likely to put pressure on China to allow the yuan to weaken further against the US dollar, in order to make Chinese-made goods more competitive in global markets.

Already, the slowdown in Chinese demand is taking a huge toll on commodity prices, pushing prices of iron ore, copper, coal and oil sharply lower. This has hit the earnings of big resource exporters, pushing countries such as Russia and Canada (major oil exporters) and Brazil (a big iron ore exporter) into recession.
Other emerging countries – particularly in Asia – are also suffering as waning Chinese demand hits their export sales. At the same time, investors, worried about the sharp slowdown in global growth, have been rushing to sell their emerging market assets, pushing the currencies of many countries sharply lower.
As a result, many investors are worried that we could be on the brink of a fresh emerging market crisis.
John Burbank, who runs the successful hedge fund Passport Capital, argues that the years of money-printing by the US central bank has resulted in a misallocation of capital, which has sown the seeds for the next financial diaster.

 "The wrong people got the capital – emerging markets countries and corporates and a lot of cyclical companies like mining and energy, particularly shale companies – and this is now a major problem for the credit markets," he told the Financial Times.
He added that investors were not recognising the risks. "I think we are on the precipice of a liquidation in emerging markets, and this feels the way that the fourth quarter of 1997 felt."
All the same, persistent concerns over the health of the global economy are causing an increasing number of investors to flock to the safety of US Treasury bonds.
This week a $US15 billion sale of short-term US government debt attracted record demand, even though the securities, which will mature in a month, were sold with a yield of zero.
Demand for short-term US Treasury debt – known as T-bills – has been so strong that some of the yields on bills maturing in a week to a few months have been trading around zero, or even slightly below zero, over the past week. (Bond yields fall as bond prices rise).
An investor accepting negative yields buys at a price of more than 100 cents in the dollar, meaning that they will incur a small loss if the debt is held to maturity.
Meanwhile, the yield on benchmark 10-year US bonds touched a one month low of 2.1 per cent this week (down from its peak of 2.5 per cent in June) as investors worried about declining global growth, problems in emerging markets and the dearth of US inflationary pressures.

[dreamybear]

We are living in strange times ..... 

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The bond market is also underpricing risks
Tong Kooi Ong 2/08/2019, 2:36pm

(Aug 5): Interest rates around the world are heading lower as major central banks embarked on a fresh round of monetary easing. The US Federal Reserve cut its short-term policy rate, by 25 basis points as widely expected, for the first time since the end of the global financial crisis (GFC).

Earlier, the European Central Bank (ECB) signalled that it was ready to push deposit rates further into negative territory and restart quantitative easing (QE).....

Central bankers remain convinced that cheap and cheaper debt is the answer to flagging growth. The resulting extraordinary monetary policy easing over the past decade has been key in driving up global indebtedness — though economic growth has been disappointingly sluggish.

Near-zero and negative interest rate policies have mostly benefited asset owners. The flood of liquidity has lifted prices for almost all asset classes — bonds, stocks, property and even gold — concurrently higher.

At the same time, they are devastating to individual savers as well as pension and insurance funds. Sustained low returns will result in a serious shortfall in financial targets over time through a compounding effect, which could lead to a full-blown retirement crisis in the future. Easy money is widening the inequality divide.

As interest rates continue to drop, investors are desperate for that little bit of extra yield. And that, I believe, is causing many to underprice risks.

This is compounded by investors leveraging up for the small positive returns over cost of funding since their borrowing cost is also falling, amplified by readily accessible liquidity.

Last week, I wrote about how equity investors appear to be underpricing the risks of highly geared companies. Current stock valuations are on the high side of historical ranges and do not appear to discriminate based on relative balance sheet strength. Companies with weak balance sheets and cash flows are especially vulnerable to any downturn in the economy and/or a reversal in the interest rate downtrend.

The bond market too seems to be mispricing risks, perhaps to an even greater degree. Table 1 shows the current yields for select 10-year government bonds. In Europe and Japan, yields are negative, that is, they give less than zero returns if held to maturity......

An investor willing to accept negative annual returns for up to 20 years in perceived risk-free German bonds is shocking enough. But when risky junk bonds and emerging-market debt also start to give less-than-zero returns and investors oversubscribe on Austrian bonds to earn just a 1% nominal annual return for the next 100 years, one must question the efficacy of the risk pricing mechanism.....

More details : http://www.theedgesingapore.com/capital/...cing-risks

[dreamybear]

I am not trying to sound like a doomsayer, but imo, the future looks bleak for deposit/savings/fixed income yields. Hv to grow retirement nest as early as possible.

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In a world of negative yields, Singapore government bonds still pay interest

TOKYO • Singapore is offering a rare opportunity to buy positive-yielding quality bonds in a world that is rapidly turning negative.

The city state, which pays the highest returns among economies that have AAA credit ratings from all three major agencies, will sell reopened July 2029 government debt worth US$2.9 billion (S$4 billion) on Wednesday, the second-largest amount on record for 10-year tenors.....

Germany, Denmark, the Netherlands and Finland now have all their bonds across the spectrum - one year to 10 years and beyond - trading with negative yields. Sweden, France and Japan are not far off being totally negative too.

The yield on the benchmark United States 10-year Treasury bond remains in positive territory - but only just, and it is trekking down.

Government bonds are not the only investments producing negative returns.

Negative-yielding corporate debt also recently passed US$1 trillion in market value, CNBC reported last week.

Read more : https://www.straitstimes.com/business/ec...y-interest