America s Bond Market Blues

The US bond market agrees with me.

How Scary Is the Bond Market?

The bond market and share prices have responded to all of this bad news in a predictable fashion.

Indeed, the bond market channel is unlikely to boost growth.

Hence, the Fed s intervention in the housing market is really an intervention in the government bond market the purported switch from buying mortgages to buying government bonds is of little significance.

Until there is a market for such bonds, we cannot know what the price will be.

Medium term fiscal reform, for its part, will be pushed by bond market vigilantes.

Indeed, the stock market is an important component of any modern economy.

In parallel, the ECB has announced an outright monetary transactions (OMT) program to purchase bonds already trading on the secondary market.

Bond market vigilantes already have taken aim at Greece, Spain, Portugal, the United Kingdom, Ireland, and Iceland, pushing government bond yields higher.

The sub prime crisis has diverted attention from rising fears about Sovereign Wealth Funds (SWF s) as the new bogeyman of global finance.

Encouraging participation by foreign investors is a quick way to jump start local bond market activity.

Surprisingly, the bond market still seems almost oblivious to this risk.

Nor is there any pressure from bond markets to concentrate the minds of policymakers.

But the minute the sub prime crisis subsides, anxieties about SWF s will return.

The solution suggested by the Governor was to borrow about 400 million on the bond market to offset the deficit.

It could do so by buying Italian and Spanish bonds in the secondary market with the pre announced intention of keeping their sovereign interest rates below a certain threshold for a certain time.

But the stock market does not guarantee returns it does not even guarantee that the stock values will keep up with inflation and there have been periods in which they have not.

The bonds can be sold to a worldwide market by insurance companies that incur major risks by writing policies.

A major concern of the German Constitutional Court is the similarity between the ESM s Secondary Market Support Facility (SMSF) and the ECB s OMT program, both of which imply the purchase of government bonds in secondary markets.

Proponents of OMT counter that the Treaty forbids only direct government bond purchases indirect purchases in secondary markets are allowed.

The Asian bond market and Asian bonds are thus mechanisms for financing for development that also promote greater regional economic stability.

And the international bond market has expressed its approval by cutting interest rates on Italy s ten year bonds to 4.8 , and on Spain s to 5.5 .

Such events are commonly priced in the derivatives market, which puts the price for the S P event at ten cents on the dollar.

The semifinal between Italy and Germany presaged the apparent willingness of Chancellor Angela Merkel to give in to Italian demands for support of the government bond market.

That is the future that the bond market sees for America a slack and depressed economy, if not for the next generation, at least for most of it.

And, because people trade bonds for commodities, cash, and stocks, the prices of government debt are the rate of inflation, the nominal interest rate, and the level of the stock market.

The market for GDP linked bonds would arrive at a price that makes them attractive to investors, reflecting expectations and uncertainties about the issuing country s future.

Because a gradual path establishes long run fiscal discipline, it would not crash the bond market, as an outright cancellation of the tax increase might.

A liquid, cash settled futures market that is based on an index of home prices in a city would enable a homeowner living there to sell in a futures market to protect himself.

It was not a populist message, because the ECB does indeed have the firepower to buy enough sovereign bonds on the secondary market to put a ceiling on interest rates, at least for many months.

A compliant bond market, which may well be the next bubble, is mistakenly viewed as the ultimate validation of this myopic approach.

It is also true that whenever Republicans rattle their sabers about the debt ceiling, and threaten not to raise it, the bond market yawns and there is no significant impact on yields.

Indeed, the US stock market and many others have rebounded more than 100 since the lows of 2009 issuance of high yield junk bonds is back to its 2007 level and interest rates on such bonds are falling.

It is a question that I am repeatedly asked at seminars and conferences. After all, participants in the housing and equity markets set prices with a view to prices in the bond market, so contagion from one long term market to another seems like a real possibility.

BERKELEY August 2 marked the first anniversary of the European Central Bank s outright monetary transactions program, under which it stands ready to purchase government bonds on the secondary market.

Real estate rental yields and stock market payouts are low, and real estate and stock prices may well fall as much as or more than bond prices if interest rates spike.

And the European Central Bank has begun to buy government bonds, including those of Greece, at prices well above those that would prevail in a free market.

For 18 months, it has been buying government bonds worth more than 200 billion ( 254 billion) on secondary markets under its Securities Market Program.

Secondary School

Japan s ability to trudge on in the face of huge adversity is admirable, but the risks of crisis ahead are surely greater than bond markets seem to recognize.

The members of the Association of Southeast Asian Nations and China, Japan and the Republic of Korea (ASEAN 3) and the Asia Cooperation Dialogue are considering developing the Asian bond market.

Indeed, the stock market is an important component of any modern economy. But we should not make plans that rely on high returns, as many (including some governments) appear to be doing.

The Battle of the Bonds