Mostly Economics

Despite easing policy stance, Indian govt bond yields jumped in India tracking MAT issue and global volatility. This led to certain corporates shelving plans to raise corporate bonds as well.

The rising yields have dampened the sentiment among investors. According to issue arrangers, Steel Authority of India (SAIL) and GIC Housing Finance are among companies that were planning to raise funds through private placement of bonds but have deferred the issuances after seeing the response. The yield on the 10-year benchmark government bond has hardened by 19 basis points in the last two weeks in line with global debt market yields, over concerns of rising oil prices. A weaker rupee and foreign fund outflows from the domestic share and debt markets have also been hurting.

“Due to the recent volatility of markets and upsurge in yields, companies are postponing their bond issuances. The appetite of investors has got impacted. GIC Housing Finance and SAIL postponed their issuances. Both were planning to raise three-year paper but they found the bid levels high for raising funds,” said Ajay Manglunia, senior vice-president (fixed income), Edelweiss Securities.

Similar trends are seen across some countries as well. Of all countries, Germnay has seen a jump in yields. The article says how stability breeds instability:

Central banks are getting a painful lesson in how their efforts to stabilize markets and boost their economies can, occasionally, do the opposite. The latest example is the brutal selloff in the German bond market. Yields on the 10-year German government bond, or “bund,” hit 0.67% Tuesday, up more than half a percentage point in just three weeks.

It’s hard to pinpoint a fundamental factor driving this. Yes, the European economy is doing better than expected, and Greece has, for now, avoided default or an exit from the euro as it wrangles further with its creditors over the terms of its bailout. Both factors have attenuated the “flight to safety” that made bunds so attractive.

But the main driving factor driving yields up is more technical than fundamental, and is in a strange way the result of central banks’ success in pushing yields down. Those efforts have led investors and traders to take on bigger positions, according to strategists atJ.P. Morgan. But when prices start to move against them, they respond by shrinking their positions, which can accelerate the movement in prices.

This is not the first time it’s happened. Last October, it was Treasurys, whose yields shot from 1.865% to 2.15% in a single day and eventually climbed to 2.4%. In the spring of 2013, something similar happened to Japanese government bonds.

What all three had in common, according to Nikolaos Panigirtzoglou and his colleagues at J.P. Morgan, is that all were driven by investors and traders using a risk management technique called “value at risk” (or VaR) that causes them to take on larger positions when volatility is low, because the steep price swings that inflict large losses are less likely.

Central banks have bought massive amounts of government bonds and used forward guidance to reassure investors that interest rates will remain near zero for a long time to come, a strategy aimed at lowering the cost of credit, encouraging investors and businesses to invest more, and raise inflation, which is now too low.

In the process, they have taken much of the guess work out of interest rates in recent years, causing bond market volatility to collapse. In that environment, VaR encourages traders to take on ever large positions. Markets are now heavily populated by VaR-sensitive investors: hedge funds, mutual fund managers, dealers and banks.When volatility ticks up, VaR also prods them to unwind those positions to avoid big losses, causing volatility to spike higher.

These movements are further exaggerated by the decline in bond market liquidity, i.e. the lack of dealers willing to take the other side of a client’s trade, due to a variety of structural and temporary factors. For example, dealers routinely “borrow” bonds from long-term holders such as insurance companies to facilitate their transactions. But German investors have become increasingly reluctant to lend out their precious bunds. Liquidity has been a particular problem for the futures contract on the 30-year bund, J.P. Morgan says.

“This volatility induced position cutting becomes self- reinforcing until yields reach a level that induces the participation of VaR-insensitive investors, such as pension funds, insurance companies or households,” Mr. Panigirtzoglou and his colleagues write. They refer to these episodes as “VaR shocks.”

VaR’s limitations are well known. By design it excludes or downplays rare episodes of extreme volatility. It is meant as a risk management tool, not a robotic buy or sell device. Yet VaR mimics the limitations of our own brains, which have trouble assuming circumstances that are at odds with those we have recently lived through.

Hmm.. Further:

Decades ago the late economist Hyman Minsky identified a similar phenomenon in the broader economy. A long period of steady growth with low inflation can persuade firms, workers and investors that recessions and crises are a thing of the past, and take on more risk as a result, for example by buying overvalued assets with debt.

“Stability is destabilizing,” Mr. Minsky said. He didn’t survive to see that prediction come true with a vengeance in 2008, an event Paul McCulley, then of Pimco, dubbed a “Minsky moment.”

Thus, in a larger sense, central banks’ efforts to hold down bond yields suffer from a similar shortcoming to their much bigger efforts to stabilize the economy, hold inflation low, and maximize employment. The more successful they are, the more they plant the seeds for a reversal of that success.

This is not a reason to abandon those efforts, because most of the time, they succeed (and are, in any event, better than the alternative, which is to do nothing). It is a reason to be aware of their limitations.

It also means central bankers need to be careful before assuming that market prices reflect fundamental developments. Many saw the big drop in German bond yields until mid-April as a ringing affirmation of the success of the European Central Bank’s bond-buying program. Similarly, some will see the recent selloff as evidence of failure. Neither sentiment is true.

Most of the time central banks only go wrong. The hubris they show over their control over economy only leads to huge failures later on. You keep going back to Austrians who have deplored all this rise of central banking and their interventions in economy..