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People should be worried about bond liquidity. In a normal interest rate environment, bonds are income producing instruments and if you don't need to sell and
by bcg1 11y ago
People should be worried about bond liquidity.
In a normal interest rate environment, bonds are income producing instruments and if you don't need to sell and are ok with the interest rate, liquidity doesn't matter quite so much. However with near-zero rates for the last 5-6 years, bonds are only making money as long as there is actual deflation (which however increases default risk) or if yields keep dropping (which beyond zero becomes some weird sort of Einstein-Bose finance where people pay others for the privilege of lending them money). In this type of environment you can't just hold the bond to maturity and live off of the income... to cash out you must sell, so liquidity is critically important.
The "flash crash" rhetoric in the article is a red herring. Much more troubling would be an actual fundamental shift in the market... the bonds markets are so huge that even small moves could prove to be seismic...
I've always thought that preventing this was the true purpose of QE, and is the reason that the Fed quadrupled its balance sheet with little effect on the headline CPI or other mainstream measures of inflation... however it might not be a stretch to say that the hyperinflation that all the doomers were predicting is playing out in the bond markets. If that is the case, and the liquidity dries up because QE is over and everyone who was frontrunning the Fed decides to cash out... yikes
- lifeisstillgood 11y agoCould you explain the hyperinflation playing out in bond markets bit please?
- bcg1 11y agoMy use of the word "hyperinflation" was hyperbole referring to a commonly held view that unprecedented money printing by central banks could lead an inflationary nightmare, often asserted by doomer goldbugs. The polar opposite view seems to be the Keynesian theologians who believe that any level of money printing & gov spending are awesome++ and point to measures like the CPI that have not really moved even as the monetary base in the US has quadrupled since the financial crisis. What I meant with my comment is that perhaps the goldbugs were right about the problem but wrong about the effects and that the orthodoxy is wrong that everything is ok++ and there is nothing to worry about. Here's some dots to connect if you want to deduce my line of thought: https://research.stlouisfed.org/fred2/series/DGS30 https://research.stlouisfed.org/fred2/series/DGS30 (change the time period to 'Max') http://research.stlouisfed.org/fred2/series/WALCL http://research.stlouisfed.org/fred2/series/WALCL http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newssearch&cd=1&cad=rja&uact=8&ved=0CB0QqQIoADAA&url=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F9d794036-09cd-11e5-a6a8-00144feabdc0.html&ei=u5JwVafSE621sATrgoG4Dw&usg=AFQjCNHB6G-va1vyk3IT6R_55vMRd3brTQ&bvm=bv.94911696,d.cWc http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=newsse...
- toomuchtodo 11y agoWould CPI not budge because QE is flowing into asset classes that don't effect directly effect the majority of consumers? While its not preferable that QE creates real estate or stock market bubbles, it is preferable to have the bubbles there instead of commodities people need to live (oil and food).
- rrggrr 11y agoLiquidity has to flow somwhere and in the instant case its likely to treasuries if other bond classes crash. As destabilizing as that would be for holders of the distressed bonds, and for borrowers who need to raise capital, its arguably very stabilizing for treasuries and offers the Fed its long-term exit from unprecedented balance sheet inflation. Treasury holders will be paying the cost for the Fed to retire debt as I see it.
- bcg1 11y agoI agree I think that dynamic could definitely play out... I'm less sanguine about how orderly such a shift would be in practice however, and the level of complexity in financial markets today I am skeptical that destabilization would be limited to holders of distressed bonds (even if it was, those bondholders are probably major institutions whose problems could lead to more bailouts, derivatives being triggered, etc)