Author Topic: Explain bonds(markets) to me  (Read 2429 times)

perulv

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Explain bonds(markets) to me
« on: August 07, 2019, 11:50:03 PM »
Yes, the question is almost as naive as the subject indicates.

This question is related to all the news these days about a "bonds bubble", negative interest rates etc.

In my simple world, a bond was something you bought and and collected "interest" on. I do understand that they have a market price, different quality/riskiness have different yields and you can speculate in the price-changes (e.g. buying them on the cheap during the 2008 financial crises, the proverbial 60 cents to a dollar).

What I do not get, is stuff like this: https://twitter.com/Schuldensuehner/status/1158845514235961345
The tweet says it all I guess, "Investors bet that they will be able to sell the bonds to the next fool at a higher price.".

But if I read this correctly, "the market" pays 180 euro for an instrument that will pay you back 100 euro, and in the meantime yield... nothing?
If so, it seems pretty obvious that this has a great chance of falling back to 100 ish... but is it that simple? In general, when I look at something and figure "hah, everyone else are idiots", there is something I'm missing :) The market tends to be relatively rational, at least more often then I would like it to be.

There are tons of articles about the "trillion dollar bubble" (https://www.bloomberg.com/news/articles/2019-06-26/trillion-dollar-monster-lurks-as-bonds-price-out-duration-risk).

I find it hard to believe that fund managers around the world are buying 100 dollars for 180. What am I missing? And if they were, would it matter if the interest-rate moved in one way or the other (triggering sell-off, as some articles hint at), as the price is so totally detached from the underlying value anyway? Is the fear that investors will wake up and understand that this is crazy, and start selling? What would be the direct and indirect consequences for the equity-investors in (presumably) high quality companies with relatively little debt?

Or is the bubble on the other side of the table, the fact that corporations have taken on an enormous level of debt?

I would really appreciate your insights.
« Last Edit: August 08, 2019, 12:04:23 AM by perulv »


wachtwoord

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Re: Explain bonds(markets) to me
« Reply #1 on: August 08, 2019, 04:19:17 AM »
Institutions that hold lots of "cash" (e.g. banks) have to store it somewhere. They think (on aggregate) a guarenteed loss on the bonds is superior to the alternatives.

Additionally, the rates are really only this low becausecof central bank inteference (primarily QE). People need to accept we don't have a free market (in fact, at least since the inception of central banks, we never did).
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Cigarbutt

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Re: Explain bonds(markets) to me
« Reply #2 on: August 08, 2019, 05:56:49 AM »
Disclosure: not a forecast, just a comment about potential downside risk.

We have recently lived in a world of low (although slowly declining) and quite stable inflation and have got used to it. It seems that (extreme) non-linear circumstances can occur at the (extreme) margin.

During the Weimar hyper-inflation episode, people, on their way to work in the morning, would bring their bags of money to buy bread and not wait for their return at the end of the day because the price would have increased significantly in the interim.

During deflationary episodes, people learn to postpone buying and investing as they expect things to get cheaper (people buying bonds now seem to expect somehow that their real purchasing power may be higher when the bond is eventually redeemed at face value). This may give rise to a paradox of thrift and it then may become unusually difficult to awaken animal spirits.

By inverting, if I were a central banker, what would I do to cause a significant deflationary episode? I would institute and repeat easing programs and contribute to the debt overhang. But who said that central banks should be contrarians?
« Last Edit: August 08, 2019, 06:00:33 AM by Cigarbutt »

mcliu

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Re: Explain bonds(markets) to me
« Reply #3 on: August 08, 2019, 06:01:01 AM »
Random thought:
Maybe, you can still achieve positive returns when you buy bonds at 180% of par.
Just sell it to the ECB for 190%.
The ECB can be the "greater fool" of last resort.  ::)

thepupil

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Re: Explain bonds(markets) to me
« Reply #4 on: August 08, 2019, 06:21:31 AM »
I'm not aware of many (any?) fund managers buying negative yielding debt. It's all institutions that have non-economic motivations (central banks, banks for regulatory reasons, etc).

A notable instance of economically minded investors owning negative interest rate debt is anyone who owns an international bond index fund.

https://investor.vanguard.com/mutual-funds/profile/overview/vtabx

For example, VTABX has an SEC yield of 0.45%, a maturity of 9.7 years, and duration of around 9 ish as well, that's because it owns a bunch of JGB's, bunds, etc. So there's an example of $130 billion of folks retirement money that is investing in this stuff.

Ross812

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Re: Explain bonds(markets) to me
« Reply #5 on: August 08, 2019, 06:44:32 AM »
I'm not aware of many (any?) fund managers buying negative yielding debt. It's all institutions that have non-economic motivations (central banks, banks for regulatory reasons, etc).

A notable instance of economically minded investors owning negative interest rate debt is anyone who owns an international bond index fund.

https://investor.vanguard.com/mutual-funds/profile/overview/vtabx

For example, VTABX has an SEC yield of 0.45%, a maturity of 9.7 years, and duration of around 9 ish as well, that's because it owns a bunch of JGB's, bunds, etc. So there's an example of $130 billion of folks retirement money that is investing in this stuff.

To be fair, the SEC yield is pretty meaningless for VTABX because the majority of bonds it holds pay annually in December. The SEC yield is based on the last payment of 0.0207 paid on 8/1 projected over the year. Last December's payment was 0.438. The SEC yield will be 20% plus in December ;-) .
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thepupil

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Re: Explain bonds(markets) to me
« Reply #6 on: August 08, 2019, 06:57:07 AM »
Looking at the bonds the fund holds, don't see a bias toward december pay bonds at all. the yield to maturity was 0.7% as of 6/30, which is stale because prices have gone up and yields going down.

I think the yield to maturity is somewhere between 0.4% and 0.7%, perhaps, 0.6 or something. The overall point stands.

If you index in the bond market outside the US, you're buying negative yielding debt.

This is a problem with Target Retirement funds, in my view.

Jurgis

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Re: Explain bonds(markets) to me
« Reply #7 on: August 08, 2019, 07:19:48 AM »
If you index in the bond market outside the US, you're buying negative yielding debt.

Bond market indexing makes much less sense overall compared to stock market indexing.
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perulv

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Re: Explain bonds(markets) to me
« Reply #8 on: August 08, 2019, 07:30:50 AM »
I'm not aware of many (any?) fund managers buying negative yielding debt. It's all institutions that have non-economic motivations (central banks, banks for regulatory reasons, etc).

A notable instance of economically minded investors owning negative interest rate debt is anyone who owns an international bond index fund.

https://investor.vanguard.com/mutual-funds/profile/overview/vtabx

For example, VTABX has an SEC yield of 0.45%, a maturity of 9.7 years, and duration of around 9 ish as well, that's because it owns a bunch of JGB's, bunds, etc. So there's an example of $130 billion of folks retirement money that is investing in this stuff.

So.... the bond itself "should" yield close to (actually less than) nothing. But when I (as a random person with no financial skill) look at my pension-savings, I see that this presumably super-safe investment is up 10% in a year. Is that part of the "bubble"-factor here?

Institutions that hold lots of "cash" (e.g. banks) have to store it somewhere. They think (on aggregate) a guarenteed loss on the bonds is superior to the alternatives.

Additionally, the rates are really only this low becausecof central bank inteference (primarily QE). People need to accept we don't have a free market (in fact, at least since the inception of central banks, we never did).

This is interesting. As a bank I _have_ to put these billions (for capital requirements) somewhere, and there are strict regulations on what instruments. So I have to put them into these "safe" instruments, even if I fully realize that the current price (vs value) of these instruments are way high.... unless there are accounting-rules for how to value these (different from the price), could't that mean that when the price at some point aligns with the value (par?), the bank is suddenly a few billions short of their capital requirement  :o

RuleNumberOne

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Re: Explain bonds(markets) to me
« Reply #9 on: August 08, 2019, 09:52:34 AM »
perulv,

You are exactly right in both your posts. Bloomberg has 3 articles in today's edition saying the same thing.

One of the Bloomberg articles calls it the dot-com moment for the bond market. I have been posting the same thing for the last few months at CoBF.

The Austrian 100-year bond has already climbed to 191 (it was 180 in your first post). If it goes back to 100 it is a big loss.

In todayís bond market, it seems as if no price is too high.
https://www.bloomberg.com/news/articles/2019-08-07/the-furious-global-bond-market-rally-shows-few-signs-of-abating

The ECB Is Dragging Us Deeper Into Madness
https://www.bloomberg.com/opinion/articles/2019-08-08/ecb-is-dragging-the-bond-market-deeper-into-yield-curve-madness?srnd=premium

This Might Be the Bond Marketís Dot-Com Moment
https://www.bloomberg.com/opinion/articles/2019-08-08/this-might-be-the-bond-market-s-dot-com-moment?srnd=premium