Podcast 5th June 2015
ECB President Mario Draghi said that bond markets have to get used to volatility given low levels of yields and that the Central Bank would not factor bond volatility into their policy objectives. The reason Draghi spoke about bond yield volatility is the high volatility exhibited by some of the most liquid securities in global financial markets, which are US Treasuries and German Bunds. Ten Year German Bund yields moved up by 17bps after Draghi’s statement, taking the yield to 0.88%, which is almost 80bps up from lows seen in April 2015. Ten year US Treasury yields moved up 12bps following German Bunds taking the yield to 2.36%, which is up 46bps from levels seen in April.
The new fear in the markets is now illiquidity in even the most liquid of securities. Illiquidity in bonds at a time of Global Bond Bubbles is a huge threat to financial market stability. The noted economist Nouriel Rubini listed the causes of bond market illiquidity that included the fact that traditional market makers for bonds, the global banks, have cut down their bond holdings substantially post the 2008 financial crisis due to stringent capital requirements. Banks are no longer providing the depth necessary for the bond markets to function smoothly in times of stress.
The liquidity unleashed by central banks from the Fed to the ECB that has seen Central Bank Balance Sheets rise three to four times over the last eight years has flown to the bond markets from sovereign debt to junk bonds. View my presentation on Global Liquidity and Bond Bubbles that I made in our Second Knowledge Workshop on Liquidity on the 22nd of May 2015 to know all about where the Central Bank Liquidity has gone.
Mutual funds have seen their fixed income assets multiply on the back of liquidity infusion by central banks and any herd behavior by investors in exiting funds would lead to a sharp rise in volatility in the global bond market. The FSB (Financial Stability Board) is actually contemplating categorizing asset managers as too big to fail and placing regulations on them as they have done with banks.
What does this illiquidity in global bond markets mean for India? India felt the market volatility in the “Tantrum” thrown by global bond markets in 2013 when the Fed started contemplating withdrawal of QE. US treasury yields rose sharply by 100bps in a one month period leading to a carnage in global bond markets. FIIs sold INR bonds on Fed withdrawal of liquidity fears, leading to both bond prices and the INR falling sharply. RBI had to squeeze liquidity to stem the volatility in the markets.
FII’s invested USD 27 billion in INR bonds in fiscal 2014-15 and have utilized 85% of total bond limit of USD 81 billion. FII’s exposure to INR bonds is at an all time high and any volatility in global bond markets will definitely be felt in India. Hence it is extremely important to keep a watch on global bond market behavior especially given illiquidity in the markets. Government and RBI too would need to pay extra attention on potential liquidity threats to Indian bond markets.
Attend our Knowledge Workshop on Managing Yield Curve and Credit Spread Risk on Fixed Income Portfolios to be held on the 17th of July 2015 at Sofitel BKC Mumbai. Please call Neelima at +919819770641 or log in to INRBONDS.com to register. Thank you for listening in.
Banks appetite to provide credit to the economy has diminished substantially due to accumulation of bad loans. Non Performing Assets and Restructured Assets have grown at a CAGR of 28% to 42% over the last six years. Bank credit growth has fallen sharply from levels of over 20% to levels of below 10%.
India has a long way to go to achieve sustainable GDP growth and that would depend on a host of global and domestic factors turning positive. It still remains to be seen if factors driving India’s growth turns positive.