Post by unlawflcombatnt on Jul 12, 2007 2:38:17 GMT -6
Here's a another good article on the bond market from the the British "Guardian." (Another good find, courtesy of patrick.net)
On borrowed time: markets stare into abyss
"The bond market has seen a dramatic sell-off in recent weeks. Householders are already feeling the effects after being hit by higher mortgage costs, but that's not the half of it."
by Heather Stewart
"Bonds are meant to be safe, predictable and boring. Yet the earthquake in the debt markets which has sent bond yields shooting up over the past month will be felt around the world, from Britain's teetering housing market to the pockets of private equity barons. Cut-price borrowing has fuelled a multitude of booms; and as the price of debt rises, investors everywhere are vulnerable.
Back in the late 1980s, bond traders were the 'big swinging dicks' of Wall Street, immortalised in Michael Lewis's memoir, Liar's Poker, as boorish adrenaline junkies, trousering multi-million-dollar bonuses and inventing the cult of the 'leveraged buyout' - the debt-backed corporate takeover - simply to create fresh piles of debt for them to trade.
These days, hedge fund managers and private equity bosses, not fixed income traders, are the new masters of the universe; but the dramatic sell-off in the bond markets over the past few weeks could have more momentous consequences than even the boldest private equity coup.
Falling bond prices mean rising yields, and that means higher borrowing costs for everyone. Analysts fear a whole bath of bubbles could be about to go pop.
The jump in yields is the end of a long, long story. During the aftermath of the dotcom crash five years or so ago, central banks around the world slashed interest rates to cushion their economies against recession. They kept borrowing costs low for years, encouraging consumers and companies to pile up a mountain of cheap debt.
Since the global economy has recovered, and inflation has picked up, central banks have pushed up the short-term rates they can control. Yet the cost of longer-term borrowing, determined in the markets by how much investors are willing to pay for bonds, has stubbornly refused to rise. Former Federal Reserve chairman Alan Greenspan called this a 'conundrum'.
Over the past few weeks, this long-running puzzle has finally begun to be resolved. Stung by losses in the US sub-prime mortgage market, and nervous about continuing high inflation, investors have become much less keen on paying high prices for potentially risky debt. Bond prices have plummeted; yields have shot up.
Central banks have been warning for some time that investors may be paying too much for risky assets. In a normal market, investors want to pay lower prices for longer-term or riskier debt, in order to allow for future inflation, or default; but the 'spreads' between the yields of different bonds have been tiny in recent years. Since the losses suffered during the sub-prime crisis, however, many investors have responded by rethinking how much risk they are willing to carry in their portfolios.
'I think greed is switching to fear,' says Julian Jessop, of Capital Economics. 'Even if you don't have any exposure to sub-prime, you might look at your portfolio, and think, "maybe I'm paying too much".'
This process is already having powerful knock-on effects. The higher bond yields are, the more expensive it is to borrow money. Suddenly, the calculations for a whole range of debt-backed investments and deals look different.
Wall Street bank Bear Stearns was forced to bail out a pair of its hedge funds which had invested heavily in sub-prime mortgage debt. The sale of UK retailer New Look was pulled at the last minute, as potential buyers baulked at the cost of debt; and a long list of corporate bond-issues has been cancelled in the face of falling appetite for risky assets.
Yields dropped back slightly last week, but market-watchers believe this is only a blip and that they will continue to rise. 'I think it will be a slow process,' says Peter Dixon of Commerzbank. 'It's like watching ripples across a pond. Bond markets to start with, then corporate credit markets - and you're already seeing equity risk measures moving to slightly higher levels.'
'When you've had a long boom, it takes an awful long time for reality to sink in,' agrees Graham Turner, of consultancy GFC Economics. 'People haven't quite cottoned on to the fact that this could be a multi-year bear market.' The consequences of a downturn in the credit markets are especially tough to predict, because of a proliferation of exotic new financial products in recent years. Lenders have been packaging up liabilities, chopping them into chunks and selling them on to other investors in complex instruments such as 'collateralised debt obligations' (CDOs).
That comforts banks, which feel they have offloaded risks, but it makes it hard to ascertain who owes what to whom - and which domino could be the next to fall.
As the Bank for International Settlements, the club of central banks, put it in its annual report last week: 'Assuming that the big banks have managed to distribute more widely the risks inherent in the loans they have made, who now holds these risks, and can they manage them adequately? The honest answer is that we do not know.'
Anthony Bolton, the high-profile former chief investment officer of Fidelity, warned last week of 'major risks' with CDOs, saying that they 'prolong the party and put off the day of reckoning'.
'In the old days, if you had a credit crunch, the authorities knew where to go: they went to the lenders, and looked at their books,' says Andrew Clare, professor of portfolio management at the Cass Business School. 'Now, when a lot of the banks have got a lot of this off their books, it's not easy to know where to look.'
The consequences of a sudden wrench in debt markets may be impossible to predict; but they will certainly be widespread, hitting any market where investors have borrowed in order to bet. 'Almost every market has benefited from increased risk appetite,' says Jessop. 'Things like the M&A boom of recent years will probably come to an end.' Roger Bootle, economic adviser to Deloitte and Touche, has warned that even top-notch wines and fine art could be vulnerable, as the flood of cheap money dries up.
As Bank of England governor Mervyn King put it in a recent speech: 'Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the financiers of the past?'
Bonds: in brief
What is a bond?
It's a 'fixed income' financial product: the issuer - usually a government or a company borrowing money in the financial markets - promises to pay out a certain sum each year.
The more investors pay for a bond, the lower its yield: the percentage of its price the buyer receives annually in interest.
If you buy a bond that pays out £5 ($10) a year for £50, the yield is 10 per cent; if you buy it for £100 ($200) , the yield is 5 per cent. So when prices fall, the flipside is that yields rise.
What's going on in the bond markets?
After several years with yields at record lows, especially for long-term bonds, prices have been falling: so yields are shooting up.
Why does it matter?
If bond yields are higher, it costs more to borrow money. That could have knock-on effects in all sorts of markets where investors have borrowed money cheaply, and used it to buy other assets. For example, mortgage lenders base their fixed-rate mortgage deals on long-term bond yields."
On borrowed time: markets stare into abyss
"The bond market has seen a dramatic sell-off in recent weeks. Householders are already feeling the effects after being hit by higher mortgage costs, but that's not the half of it."
by Heather Stewart
"Bonds are meant to be safe, predictable and boring. Yet the earthquake in the debt markets which has sent bond yields shooting up over the past month will be felt around the world, from Britain's teetering housing market to the pockets of private equity barons. Cut-price borrowing has fuelled a multitude of booms; and as the price of debt rises, investors everywhere are vulnerable.
Back in the late 1980s, bond traders were the 'big swinging dicks' of Wall Street, immortalised in Michael Lewis's memoir, Liar's Poker, as boorish adrenaline junkies, trousering multi-million-dollar bonuses and inventing the cult of the 'leveraged buyout' - the debt-backed corporate takeover - simply to create fresh piles of debt for them to trade.
These days, hedge fund managers and private equity bosses, not fixed income traders, are the new masters of the universe; but the dramatic sell-off in the bond markets over the past few weeks could have more momentous consequences than even the boldest private equity coup.
Falling bond prices mean rising yields, and that means higher borrowing costs for everyone. Analysts fear a whole bath of bubbles could be about to go pop.
The jump in yields is the end of a long, long story. During the aftermath of the dotcom crash five years or so ago, central banks around the world slashed interest rates to cushion their economies against recession. They kept borrowing costs low for years, encouraging consumers and companies to pile up a mountain of cheap debt.
Since the global economy has recovered, and inflation has picked up, central banks have pushed up the short-term rates they can control. Yet the cost of longer-term borrowing, determined in the markets by how much investors are willing to pay for bonds, has stubbornly refused to rise. Former Federal Reserve chairman Alan Greenspan called this a 'conundrum'.
Over the past few weeks, this long-running puzzle has finally begun to be resolved. Stung by losses in the US sub-prime mortgage market, and nervous about continuing high inflation, investors have become much less keen on paying high prices for potentially risky debt. Bond prices have plummeted; yields have shot up.
Central banks have been warning for some time that investors may be paying too much for risky assets. In a normal market, investors want to pay lower prices for longer-term or riskier debt, in order to allow for future inflation, or default; but the 'spreads' between the yields of different bonds have been tiny in recent years. Since the losses suffered during the sub-prime crisis, however, many investors have responded by rethinking how much risk they are willing to carry in their portfolios.
'I think greed is switching to fear,' says Julian Jessop, of Capital Economics. 'Even if you don't have any exposure to sub-prime, you might look at your portfolio, and think, "maybe I'm paying too much".'
This process is already having powerful knock-on effects. The higher bond yields are, the more expensive it is to borrow money. Suddenly, the calculations for a whole range of debt-backed investments and deals look different.
Wall Street bank Bear Stearns was forced to bail out a pair of its hedge funds which had invested heavily in sub-prime mortgage debt. The sale of UK retailer New Look was pulled at the last minute, as potential buyers baulked at the cost of debt; and a long list of corporate bond-issues has been cancelled in the face of falling appetite for risky assets.
Yields dropped back slightly last week, but market-watchers believe this is only a blip and that they will continue to rise. 'I think it will be a slow process,' says Peter Dixon of Commerzbank. 'It's like watching ripples across a pond. Bond markets to start with, then corporate credit markets - and you're already seeing equity risk measures moving to slightly higher levels.'
'When you've had a long boom, it takes an awful long time for reality to sink in,' agrees Graham Turner, of consultancy GFC Economics. 'People haven't quite cottoned on to the fact that this could be a multi-year bear market.' The consequences of a downturn in the credit markets are especially tough to predict, because of a proliferation of exotic new financial products in recent years. Lenders have been packaging up liabilities, chopping them into chunks and selling them on to other investors in complex instruments such as 'collateralised debt obligations' (CDOs).
That comforts banks, which feel they have offloaded risks, but it makes it hard to ascertain who owes what to whom - and which domino could be the next to fall.
As the Bank for International Settlements, the club of central banks, put it in its annual report last week: 'Assuming that the big banks have managed to distribute more widely the risks inherent in the loans they have made, who now holds these risks, and can they manage them adequately? The honest answer is that we do not know.'
Anthony Bolton, the high-profile former chief investment officer of Fidelity, warned last week of 'major risks' with CDOs, saying that they 'prolong the party and put off the day of reckoning'.
'In the old days, if you had a credit crunch, the authorities knew where to go: they went to the lenders, and looked at their books,' says Andrew Clare, professor of portfolio management at the Cass Business School. 'Now, when a lot of the banks have got a lot of this off their books, it's not easy to know where to look.'
The consequences of a sudden wrench in debt markets may be impossible to predict; but they will certainly be widespread, hitting any market where investors have borrowed in order to bet. 'Almost every market has benefited from increased risk appetite,' says Jessop. 'Things like the M&A boom of recent years will probably come to an end.' Roger Bootle, economic adviser to Deloitte and Touche, has warned that even top-notch wines and fine art could be vulnerable, as the flood of cheap money dries up.
As Bank of England governor Mervyn King put it in a recent speech: 'Excessive leverage is the common theme of many financial crises of the past. Are we really so much cleverer than the financiers of the past?'
Bonds: in brief
What is a bond?
It's a 'fixed income' financial product: the issuer - usually a government or a company borrowing money in the financial markets - promises to pay out a certain sum each year.
The more investors pay for a bond, the lower its yield: the percentage of its price the buyer receives annually in interest.
If you buy a bond that pays out £5 ($10) a year for £50, the yield is 10 per cent; if you buy it for £100 ($200) , the yield is 5 per cent. So when prices fall, the flipside is that yields rise.
What's going on in the bond markets?
After several years with yields at record lows, especially for long-term bonds, prices have been falling: so yields are shooting up.
Why does it matter?
If bond yields are higher, it costs more to borrow money. That could have knock-on effects in all sorts of markets where investors have borrowed money cheaply, and used it to buy other assets. For example, mortgage lenders base their fixed-rate mortgage deals on long-term bond yields."