Best of the Week
Most Popular
1.UK House Prices BrExit Crash NOT Likely Despite London Property Market Weakness - Nadeem_Walayat
2.BrExit Morning - New Dawn for Britain, Independence Day! - Nadeem_Walayat
3.LEAVE Wins EU Referendum - Sterling and FTSE Hit Hard, Pollsters, Bookies and Markets All WRONG! - Nadeem_Walayat
4.BrExit Implications for UK Stock Market, Sterling GBP, House Prices and UK Politics... - Nadeem_Walayat
5.Trading BrExit - Stocks, Bonds, Sterling, Opinion Polls, Bookmaker Odds and My Forecast - Nadeem_Walayat
6.FTSE and Sterling Brexit Trading, Deconstruction of the EU Referendum Result - Nadeem_Walayat
7.UK Interest Rate Cut to 0.25% Imminent and More QE Money Printing - Nadeem_Walayat
8.Trading BrExit - British Pound Plunges, FTSE Stock Futures Slump on LEAVE Shock Referendum Win - Nadeem_Walayat
9.The Stock Market is Reading it Wrong! - Chris_Vermeulen
10.Breakouts Galore in Gold and Silver - Jordan_Roy_Byrne
Free Silver
Last 7 days
Soybean Commodity Price to Soar Again - 23rd July 16
SPX Stock Market Uptrend Continues - 23rd July 16
Gold And Silver – Debt Addiction Will Carry Precious Metals Higher, Guaranteed - 23rd July 16
Pokemon Go - How to Play, First Use, Balls, Stops, Catching Pokemon's... Great Excercise! - 23rd July 16
7 Signs That the Gold Market Remains Resilient - 23rd July 16
Basic Income in The Time of Crisis - 23rd July 16
Silver Bull Faces Correction - 22nd July 16
The Serious Warning No One’s Talking About - 22nd July 16
Stock Market Insight from Greed, Volatility, and Put/Call Ratio - 22nd July 16
What Will Happen To the Stock Market When Interest Rates Rise? - 22nd July 16
How to Escape the World’s Biggest Ponzi Scheme - 22nd July 16
Addicted to Debt - We Can’t Borrow from the Future Anymore - 21st July 16
Not Everything Is Bullish for Gold - 21st July 16
Don’t Get Sucked Back Into the Stock Market - The Big Picture Hasn’t Changed - 21st July 16
Silver – Caught Inside - 21st July 16
Forex: "The Markets Are Getting Exciting!" - 20th July 16
China Economic Troubles - Is Kyle Bass Finally Getting His Revenge? - 20th July 16
Why Lithium Will See Another Price Spike This Fall - 20th July 16
The Peak Oil Paradox Revisited - 19th July 16
SPX Challenges the Upper Trendline - 19th July 16
Missing ’28 Pages’ of the 9/11 Report Released into Blitzkrieg of World Events - 19th July 16
Likelihood of Organized Disruption at GOP Convention - 19th July 16
More on the ‘Breadth Thrust’ and Stock Market Internals - 19th July 16
FX Traders: Get a Free Week of Forecasts (Details inside) - 19th July 16
Ups and Downs in Gold and Crude Oil Price - 19th July 16
Keep an Eye on ‘Bitcoin’ as the Next ‘Financial Crisis’ Starts! - 18th July 16
Erdogan Might Have Known about the Coup but Didn’t Prevent It on Purpose - 18th July 16
More Deflation Ahead: Silver, Gold And Their Mining Stocks A Must-Have - 18th July 16
Stock Market Minor Top? - 18th July 16
5 Best Gold and Silver Junior Mining Stocks in 2016 - 17th July 16
Gold And Silver – NWO-Created Tragedies Will Never End, Seek Truth - 16th July 16
How Long Can Buybacks Continue To Support A Market Which Is Standing On A Fundamentally Flawed Premise? - 16th July 16
Will They Come For Your IRA? - 15th July 16
Gold’s Record Selling Overhang - 15th July 16
Capitalism Has Entered a New Era—and Historic Stock Market Investing Returns Are Gone Forever - 15th July 16
Gold Price Could Hit $5,000 or Even $10,000 in a Few Years - 15th July 16
Junior Gold and Silver Mining Funds or Individual Gold and Silver Mining Stocks - 15th July 16
The Soaring Risk of Flying in Bernanke's Helicopter - 15th July 16
The Broad Stock Market, Helicopters and Gold - 15th July 16
The Curious Case of Vanishing Lady Liberty; Only Gold and Silver Remember Her - 15th July 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Forex Forecasts

Will the U.S. Treasury Bond Bubble Finally Burst in 2013

Interest-Rates / US Bonds Nov 30, 2012 - 09:14 AM GMT

By: Money_Morning

Interest-Rates

Shah Gilani writes: The Federal Reserve's multi-year prescription of targeting super-low interest rates on federal funds, along with various quantitative easing programs, has pushed yields down on all fixed-income instruments to the benefit of issuers and the detriment of investors.

There is little doubt that the Fed's articulated and executed policies have resulted in a bond-bubble with both short and long-term consequences for investors and the economy.


At some point the bond-bubble will burst. But there is no certainty on when that will happen or what ultimately will cause rates to rise.

What investors need to understand is that while yields and bond prices in 2013 could remain flat relative to closing third quarter 2012 measures, yields are unlikely to fall further and prices are unlikely to rally in 2013, with the possible exception of short-term U.S. treasuries.

However, there is the possibility of what I'm calling a "skyfall."

For fixed-income investors this means there is a chance the bond bubble may finally burst.

2013 Bond Market Forecast: From Flat to Skyfall?
Skyfall is the title of the latest James Bond film, which viewers discover is also the name of Bond's childhood home in Scotland, before it is blown apart in the movie's climactic finish.

Now, because interest rates across the board have fallen to historically low levels, the great bond rally could suffer a similar climax.

Here's where we stand now, why the bond rally is likely over, what could happen in 2013, and what early warning signals to watch for to get out of the way of this skyfall.

As yield-hungry investors have plowed more and more money into bond mutual funds, bond ETFs, and, for institutions, individual bonds, issuers from sovereigns to junk dealers have rushed to the market to soak up the trillions of dollars searching for yield.

That circuitous path has kept money flowing into bonds in search of falling yields as issuers take advantage of low rates artificially manipulated by the Fed's actions.

All dollar-denominated bonds issued in the United States (and many issues globally) are priced off the U.S. Treasury yield curve.

That's the scale of interest rates that starts with the federal funds rate (even though the Fed doesn't issue fed funds) and displays the interest rates payable on Treasury bills, notes and bonds, up to and including the most actively watched, traded and talked about 10-year T-bond, all the way to the 30-year T-bond.

Treasury issues are considered "risk-free" because they are backed by the full faith and credit of the U.S. to pay all interest and principal on its debts.

All other bonds yield more (pay more interest) than equivalent-maturity Treasury issues to reflect the difference in "quality" between a Treasury issue and a municipal, corporate, or other bond issue.

The difference between what a Treasury's yield is for a particular maturity bill, note or bond and what the yield is on another issue is called the "spread."

The spread refers to the additional yield (the difference in the interest rate) issuers have to pay to attract investors who otherwise might opt for the safety of Treasuries.

As interest rates have been kept artificially low, investors looking for additional yield above exceptionally low-yielding Treasuries have been increasingly willing to accept smaller and smaller "spreads" when they buy bonds that aren't risk-free.

Issuers recognize investor demand for yield and know investors will still buy their bonds even as they offer less and less interest, because whatever yield advantage investors can get, they will gladly take.

As a result, the spread over Treasuries has come down for all issuers from top-rated investment grade issuers to leverage bond and junk issuers.

In other words, investors are not being adequately compensated for the increasing risk they are taking with issuers, who range from investment-grade corporations to special-purpose vehicles issuing junk bonds for leveraged and speculative endeavors.

The Fed's recent announcement that they will buy $40 billion per month of top-rated agency paper (mostly mortgage-backed-securities), only takes even more U.S. government-backed paper out of the market, leaving investors clamoring even more for whatever investment-grade ("IG") bonds they can get. That's a further boon to bond issuers.

In fact, in just the third quarter of 2012 (the latest quarter for which data is available) IG issuance, excluding sovereign, supranational, split-rated and preferred-stock issues, exceeded $215 billion -- a near record.

But that's IG. What's more telling, and evidence of how much investors are reaching for yield further out on the risk spectrum, is what third-quarter issuance was in the leverage and high-yield (junk) markets.

Leverage loans are loans and bond issues backing loans to corporations, companies and other issuers that already have high leverage on the debt side of their capital structure. High yield, also known as junk bonds, are debt issues offered by the most speculative issuers seeking debt financing.

Leverage bond issuance totaled $114 billion in Q3, a record, which included a constituent record $20 billion issued in August, historically the year's slowest month.

At the current pace, with $317 billion already issued year to date, leverage loans are on track to reach $423 billion, or exceed $508 billion if September's $63.5 billion pace continues.

And while the leverage loan market has been flush, the high-yield market has been doing its own hot issuance thing.

Bond-clearing yields fell in the third quarter to all-time lows, even though spreads are still above record lows. High-yield issuance in the third quarter was $91.9 billion, the second highest on record. The highest quarter ever was this year's first quarter at $99.9 billion. Full-year 2012 junk issuance is closing in on the record $287 billion issued in 2010, and likely to exceed it.

Combined leverage and HY issuance in all of 2012 is expected to exceed $748 billion, topping the former record of $679 billion reached in 2007.

We Know What Happened Next....
With rates so low and investor appetites still high, we're seeing more and more "covenant-lite" deals, the ones that afford more protections to issuers than to investors.

Investors need to look through the froth in the bond market and realize that a lot of bonds are issued with call features and are in such demand that they are trading at premiums to par value, or what will be returned at maturity.

It's imperative that investors realize that coupons, or the interest rate that a bond comes to market with, is different than what you will get on a yield-to-maturity basis if you pay a premium, or especially if you pay a premium and the bond is called long before you expect to have held it.

With prices so high and yields so low, all relative to the risk of holding bonds in a bubble-like market, investors need to have an exceptionally strong stomach to wade into the bond market now or in 2013.

Investors also need to beware of false rallies.

The risk-off trade, where equity investors flee to the safety of Treasuries, could make Treasury prices rise and bonds look like a safe haven. They could be, for a while.

Then there's the outside threat of inflation that would cause rates to rise and bond prices to plummet. Or the move to the risk-on trade, which would signal that equity investments are preferred to the low-yielding safety of bonds, which could decimate bond prices.

Or there's the chance that the economy double-dips in 2013, putting pressure on leverage loan and high-yield issuers to make interest payments at the same time that investors flee their bonds and raise capital structure costs for them.

I'll be watching the derivatives markets, namely the credit default swap indexes like CDX-IG-19 to see if default insurance costs start rising, by how much, how fast, and on which indexes.

I'll leave a light on for you, and shout out loud here and in my services if the bond vigilantes start gathering at the end of town.

Source :http://moneymorning.com/2012/11/30/2013-bond-market-forecast-is-the-bond-bubble-finally-about-to-burst/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife