5915 are the bond vigilantes back itemid 127

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Are The Bond Vigilantes Back?

Written by Paul Amery

Wednesday, 27 May 2009 19:54 (CET)
Matt, there’s one long-forgotten actor that could upset governments’ plans to create inflation.

That’s the bond market. I noticed today that the long bond yield in the US has ticked up to 4.5%, a level it last saw in August last year. Are the bond vigilantes returning?

For me, the government bond markets, and specifically the US long bond, are the key to what happens in other markets during the remainder of the year. 

Elsewhere, there are plenty of signs that conditions are improving. We reported last week that measures of bank credit risk have declined substantially over the last few months, and are approaching levels last seen before the Lehman default.

At the Edhec conference on indexing and ETFs in Paris over the last two days, a number of people I spoke to said that: first, clients are much better informed than six months ago about what counterparty risk exposures they incur when buying tracker products; and, second, that they are generally now much more comfortable with those that they do incur. 

Plus, of course, we’ve seen a number of innovations by ETF providers to reduce these exposures – from reducing the absolute levels of swap risk, to buying extra protection, to operating multiple swap provider models.

So, in general, investors are much less worried than they were even two months ago about the possibility of another bank failure, and what that might mean for an ETF investor.

But, if you go to the website of Credit Derivatives Research, who calculate the Counterparty Risk Index, you will see that, while most of the major indices of corporate credit risk have shown declining spreads (i.e., improving creditworthiness) since March, their Government Risk Index has started to increase again. In other words, investors are getting more concerned again about the major sovereign debtors’ ability to pay. It’s a small blip so far, but one to keep an eye on.

The rise in bond yields may be seen as a natural reaction to panic buying of bonds, and a fall in yields to 2.5%, at the end of last year.

But since so many asset prices are determined by reference to long-term interest rates, a significant rise in this benchmark could derail any hopes of economic recovery and strengthen deflationary pressures.


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Bond Investing
at Wikinvest


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The views expressed by Paul Amery, Jim Wiandt and Matt Hougan are for informational purposes only and should not be construed as a recommendation for any security.

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