Domestic Policy · Fiscal and Monetary Affairs

Bond Markets Are Not Yet In Bubble Territory

With the advent of Sovereign Wealth Funds(SWF) becoming more prevalent in developed and developing countries alike it has created, in my opinion a flux in the markets which these SWF’s invest in, and compete against, particularly among developed nations. One of the outcomes of their liquidity, available capital, and fiscal solvency, is the flux in sovereign bond markets. Due to the ready availability of bankable assets, and sound balance sheets, this has led to negative interest rates in many developed countries. This “crisis”, as one market watcher put it has it’s roots in such solvency. But are, as some suggest, their or “bubbles” in the sovereign bond markets? This analyst begs to differ, and here’s why. The first thing to realize is that most purchasers of bonds are not short duration investors. This helps to explain the price of 30 year bond yields in the United States, levels which haven’t been seen since the 1940s immediately following World War 2 (07/07/16).This convention is due in part to the swelling of Sovereign Wealth Funds heralding unprecedented stability in the bond, and equities markets.

The idea that sovereign wealth funds contribute to the stability of bond markets by purchasing bonds is not new, and wholly plausible (as when China purchased $800 million in Ecuadorean bonds an order to curry favor and lend stability to the country. Indeed it is the very nature of sovereign wealth funds to lend stability to a country and therefore the markets either indigenous, or exogenous. And the plurality of them in an increasingly interconnected, and globalized world only makes this more so. However to posit that the over $15 trillion in assets held by these SWF’s is based solely in the Bond markets is a fallacy of the highest magnitude. The bond markets are by their very nature long-term, and relatively safe investments, though at relatively lower return on investment (ROI) as opposed to riskier financial instruments, and investment vehicles. And though this is an investment that is much sought after due to its reliable returns, this also lends itself to a certain type of equity source. One that is generally well positioned, and not generally leveraged. This is because the cost of leveraging an asset, or cash source would far outweigh any benefits received investing solely in bond markets.

In this age of negative interest rates I think it is important for monetary policy makers to keep these two things in mind. One negative interest rates lend themselves to a riskier type of investor and so can be inherently more riskier to implement. And with negative interest rates playing a role in the discount rate, as well as the prime rate for treasuries it’s important to keep in mind that the instant ROI for securities becomes greater than the borrowing rate of leveraging cash or other assets, it lends itself to a “squeeze” which if not careful could actually spell ruin for the bond markets, and thus the sovereign’s and world economy in general. Another thing to keep in mind is the idea of geoeconomics. Or the intent of influencing the outcome of geopolitical events through the exercising of economic tools related to statecraft. Therefore western countries, and any country in general should be wary of becoming too dependent on foreign debt obtained by third party countries which are hostile to their political beliefs and objectives. Since this will allow for leveraging, and manipulation of geopolitical outcomes. As Shakespeare said “tis’ better neither to lend nor to receive. Since loan oft loses both itself and friend.”

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