Yesterday I posted my views on the the prospects for the bond market. My focus there was a U.S. government securities.
During the past year there has been a big divergence between the performance of treasury securities and the rest of the bond market - corporates, junk bonds, and mortgage securities. The credit of non-treasury securities was called into question and the prices of these securities dropped substantially as their yields went through the roof.
I expect the yields on treasury securities to rise over the coming months. But I think that the yields on junk bonds, corporate bonds, and mortgage backed securities will fall and while their prices rise. This process of returning to a more normal relationship with treasury securities will probably continue for the next year.
After that both markets will probably start moving up and down together as normal credit conditions start to prevail.
7 comments:
The Fed in March: To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.
Doesn't sound like it is there intention to let yields go up.
Carl, what are "normal" credit conditions? Treasuries and corporate bonds were moving in tandem during the credit bubble that started in the Greenspan era. Was that "normal"?
"Normal" credit conditions may not return for a while. The govt is still financing huge debt with even more humongous debt. The consumer is cutting down on debt, to be more in line with income, and we should all applaud that, as return to normalcy!
Thanks for that clarification. I own municipal bonds, so maybe they will do OK.
Carl,
Yesterday you wrote:
"There is another reason why increasing bond yields will be economically beneficial in current circumstances. They will enable banks to become very profitable again. The Fed is keeping short term rates very, very low and will continue this policy for a long time to come. Meanwhile longer term treasury bond yields are rising. A bank can therefore borrow short term money, invest it in the bond market and hedge the risk of falling bond prices. The result is an almost risk free return of about 4% currently. This will do wonders for bank balance sheets and profitability!"
Can you share specifically how banks hedge the risk of fally bond prices? I have asked my broker how banks do this and he has been no help.
Thank you
WiredPirate, falling bond prices mean higher yield.
The banks are borrowing money at 0%, and constantly buying bonds yielding 3.5% or higher. Falling bond prices give them higher yields.
The banks will dump the bonds only when the yield goes lower, i.e. they will make money on the bond trades too.
With the help of the FED and the govt, the banks are always making money, in spite of the fact that they are run by idiots on huge salaries and bonuses, and "smart", hard-working people are always losing.
carl
while i do agree that higher intrest rates tend to be bullish for the stock market and i agree that printing money is a way to reflate the stock market in nominal terms im not convinced though that it will be good for the average guy who is renting
based on your assesment that intrest rates should be in a rising trend over the next 20 years i would also take the assumption that now would be a good time to take on that 30 year fixed rate mortgage .what i gather from your assesment is that we are entering an inflationary cycle that has a long ways to go .
joe
Kishore,
With all due respect and appreciation for your response I know about borrowing short and lending long and interest rate risk. I want to know specifically how do banks hedge bond prices going down when interest rates go up to give them this "almost risk free 4% return"? What is the most efficcient regulator approved strategy? Interest rate swaps? Selling intrest rate futures? How do I copy that strategy in my brokerage account?
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