The Bond Market Explained For CNBC

EconMatters's picture

By EconMatters


Questions – Low Yields


We occasionally turn the volume up on the TV`s just to hear what others are thinking in mainstream business media with the Sales & Name Game that is business television these days and CNBC asked the following question: “Why if everybody is talking about inflation is the bond market not moving?”


Frankly, there is so much market illiteracy even among the professionals in the financial market as witnessed by the conversation revolving around high frequency trading, even by the so-called experts who commented publicly on the issue it should be expected that many market participants fail to understand the bond market dynamics regarding why yields are so low relative to expectations at the beginning of the year. 


Answers Provided


So here goes: 

  1. Bond yields rallied to the close of 2013, and they were at very elevated levels.
  2. Equities were also at all-time highs. 
  3. The first quarter was tough for two reasons weather, and an exceptionally front loaded 3rd and 4th quarters that left slack in the inventory and spending cycle. 
  4. Lots of low interest money available from many fronts, see Japan, China, US and Europe. 
  5. Makes sense given the cheap money available, yields at relative trend range highs, equities range bound, and economic data suffering because of an extremely debilitating winter and Growth Pull from Robust 3rd & 4th quarters, to put on massive yield chasing conservative carry trades. These were conservative given the aforementioned unique set of points coming together just right.

The High Yield Carry Trade Explained


Here is the trade borrow at rates from 10 to 25 basis points, and I mean borrow in exceptionally large terms (leverage), then depending upon the currency one borrowed in (there may be currency machinations involved in getting into the currency where wanting to invest this cheap loan, i.e., sell Yen and buy Dollars), then pick a ‘perceived’ low volatility asset that pays some form of Yield, i.e., 10-Year at 3%, Utility Stocks with High Yields, etc. buy this yielding asset and sit back and rake in the delta each day, week and month!

It is important to remember these key points regarding this trade 1) Low volatility instruments 2) Exceptionally Low Short-term Borrowing Rates 3) Leverage, Leverage, and more Leverage. This is why Gold has been out of favor the last couple of years because it pays no Yield! When in doubt follow the money trail, and there has been a huge amount of money made by utilizing this trade setup. 


Another requirement has to do with the market going in the direction that these investors put their vast leverage to work (or at least stays within a defined range that investors are comfortable with before losing more principal than they earn in interest carry, i.e., utility stocks going higher or bond prices going higher with yields lower).  Also depending upon the currency borrowed in a Positive Carry enhances the trade and an extremely negative carry negates this trade altogether in many cases. Google this if interested but not the scope of this piece.


Big Banks Love Leverage Yield Plays


Many investors have put this trade on and off over the last five years of QE, and recently the Big Banks have been buying up a bunch of the treasuries that the Fed is no longer buying from the start of 2014 going forward. 


I imagine this is a way to offset other areas like mortgage refinancing where they were struggling with rising rates, and everybody already effectively refinanced. The Big banks are always looking to make money and this trade sure has helped their bottom line the first two quarters of 2014.


I might also add that bonds are seasonal in nature, and many hide in bonds during the sell in May Summer doldrums. But make no mistake the reason yields are so low right now is because there is money to be made from such a market dynamic. 


Carry trades are very popular in the history of modern finance and Big Banking, and the use of massive leverage is their go to strategy where they lack creative talent who can confer a competitive market advantage – Big Banks have no talent! This is an oversimplification but anybody who is really talented can make so much more money working in other places, compensation is off the charts in some cases. 




Thus to sum up the Carry Yield Trade is the main driver of why Bond Yields are so low and utility and other high yielding stocks are so high. This trade works until it doesn’t, and it is my guess that many Big Banks figure they have the entire second quarter before they need to start unwinding this trade.


I think they have much less time, and are pushing this trade trying to pick up pennies in front of a massive steamroller of inflation coming down the road. I think the writing on the wall may be as soon as 6 more trading days and the ADP Employment Report, I sure wouldn`t want to own a bunch of treasuries going into next Friday`s Employment Report or the Fed Meeting in a couple of weeks!


Exit Strategy


But at any rate, once the Fed starts to raise rates and usually they are forced to by rising inflation (they never do it until their hand is forced) all the sudden the cheap money dries up, but long before that happens investors all start to unwind the trade, other investors pile on in the direction of the unwind, and this is where the steamroller analogy comes into play.


As massive unwinds the size required to make this kind of trading strategy work are really hairy, and oftentimes cause more losses than the money made in the prior two quarters making money on this trade by the Big Banks. However everything is quarterly results oriented and being on bonus track on a daily basis at some firms so long range foresight is often lacking in trade configurations. Did I mention a lack of creative talent at the Big Banks who often substitute brut size and scale to make money in the markets as their best investment strategy?


Economy is Picking up Pace


So the High Yield Carry Trade is why Bond yields are where they currently reside, and is this saying anything structural regarding the economy? No! Will these low yields persist through year end? Again No! And remember when in doubt follow the money, and high yield chasing earns a lot of pennies until it gets steamrolled!


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Fuh Querada's picture



“What we’ve seen over the last six months is a ramp-up in interest rate swaps to the tune of $12 trillion . . . . What the build in these interest rate swaps is achieving, it’s stemming the rise in interest rates.”

ebworthen's picture

Black Tulips will always be worth a year of the average man's wages, and soon will buy a man a house.

The South Sea Company has a deal to be the sole supplier of black tulips; you should buy some of that stock for sure.

tecno242's picture

Funny how analyst after analyst keeps insisting that bond yields will eventually start rising or explode upwards soon as "the economy is picking up pace"  ... yet... day after day... yields are tanking ... a mere 3% today, even in the face of the FED continuing to taper.

I'm sorry, but a carry trade simply cannot explain the dumpster of money flowing into bonds.  Sure there are incompetent traders/investors working for these banks, but they are not stupid.  If it was all carry, we should have seen a large flood out of treasuries when the FED first announced the Taper or hinted at it.  That didn't occur.  The bond market simply thinks that the FED's plan never properly worked and has artifically inflated prices in certain assets and those assets are going to correct causing another squeeze. 

At what point do all these "experts" stop for a second and admit something weird is going on and we are essentially witnessing huge inflation (stock market, real estate, rent, food) and expectations of deflation (bond yields and golds bear market) at the same time and that obviously someone must be hugely wrong.

wagthetails's picture

and because everytime rates will rise, it will hurt the economy, which will then drive down rates.  we won't see inflation at all, everyone will keep piling on debt until we reach a point of a complete lack of faith in the currency.  we'll go from 0% to ####% almost over night, skip right over inflation. 

But will still have lots of time.  even when japan breaks, the money fleeing the country will go to US and EU further driving up stocks and bonds.  only when that tsunami settles will we see that the US is on the same path. 

LawsofPhysics's picture

"I sure wouldn`t want to own a bunch of treasuries going into next Friday`s Employment Report or the Fed Meeting in a couple of weeks!"  -


What a douche.  Yeah, I don't want to own a "bunch" either.  I want to own a fuckload (unfortunately there's this little problem of supply) as rates cannot go up, ever.

honestann's picture

I agree.  Amazing how blind most people get when they decide to write articles.  Somehow this decision convinces people to jam their head up their butts and ignore the obvious motivations, situations and forces.

Interestingly, in one of his quarter-million-bucks a pop chats, Bernanke said rates will stay low much longer than anyone expects.  For once I agree with something this congenital liar says.

The main reason interest rates won't rise is... the economy is in depression, and getting worse.  The fed knows this, and they know all the official statistics are BLATANT LIES.  The simplest way to understand the situation is to look at a 30 year chart of the percentage of the population that is employed.

The second reason interest rates won't rise is... the federal government will need increasingly huge quantities of fiat to pay for their endlessly growing police-state, warfare-state and welfare-state expenses... and they literally cannot possibly pay market interest rates on the levels of debt they already have.

Seems like the only people who can see what is right in front of their faces are... some of the people who write comments in ZH.

Bay of Pigs's picture


Aint that the truth. So many garbage articles like this featured here at ZH now. 

honestann's picture

Something happens to people when they decide to write articles.  I'm not sure whether it is an explicit decision, or just implicit, but when most people decide to write articles they tend to adopt the same "formula" or "methodology" or "approach" and/or "tone" as mainstream articles.

In effect, they must explicitly or implicitly feel something like, "Now I need to sound-like or come-across-like other [mainstream] media sources".  All of a sudden the drop common sense and start adopting terms and approaches they never did before.  It seems to me that most do this [almost] without even thinking about what they're doing... though I'm not sure.

realWhiteNight123129's picture

EconMatters is a douche.

He should check the amount of machinery per worker. I.e. capital per worker. Japan still has a lot, US manufacturing has been falling since the 60s to Japan first, next Taiwan Korea, Next China. So the one which really fell first is not Japan, it is the US.

Another thing EconDouche:

There is nothing which supports that higher growth and higher inflation go hand in hand. In fact between 1866 and 1901, when the US came from agrarian economy to manufacturing world superpower, prices were falling the entire time....



I Write Code's picture

also posted at Seeking Alpha

so if he's right, then there REALLLY IS a shortage of bonds?  with Treasury borrowing a trillion dollars a year, there's a shortage of bonds?  I don't get it.  Whatever is going on now is different from six months ago ... isn't it?

Dingleberry's picture

Yeah....the bond vigilantes are out in farce.

Bay of Pigs's picture

They are all at the bottom of the Mariana Trench...

GFORCE's picture

The Fed can't raise rates. They're more likely to cut. Deflaton is coming when europe turns and the U.S. market is the only market in town when europe and japan lose faith, so this pennies in front of a steamroller only really applies to those nations.

The Fed is tapering, while europe looks to go the other way and with geopolitical turmoi around it's fairly easy to see why the U.S. doesn't need higher rates to attract buyers.

orangegeek's picture

Deflation has been here (and in Europe) from some time.

Ban KKiller's picture

No ONE likes to admit that the market is totally opaque these days so...pretend you know what is going on. Learn financial terms and throw them around. CNBC will hire you as a shill. When I say "you" I mean anyone.

Hippocratic Oaf's picture

Learn bond lingo, please. As to not confuse the masses.

Bond volatility is quoted as a price:  bonds rally=price goes up, yield goes down.

Bonds sell-off (get crushed/pull back)=price goes down, yield goes up.


Bonds are now rallying their fucking asses off!!!


disabledvet's picture

Massive inflation in input costs (save gold and silver...and coal interestingly. Those prices have utterly collapsed.)

Of course with wage DEFLATION (in nominal terms) plus the biggest energy boom in human history...none of this "politically acceptable"....and guess've got trillions in issuance coming and no problem finding buyers.

The US economy will be lucky not to enter a recession this year.

scraping_by's picture

Coal is tending down because the Obama administration's declared war on coal-fired electricity plants. They're using the bought-out Sierra Club as a stalking horse and have invented 'carbon dixoide pollution.' Barry uses his stern face.

Why? The beneficiaries are Big Oil, natural gas producers, the nuclear industry, and the Chinese. Like the Keystone and other pipelines, US energy assets are now reserved for powering foreign economies.

Colonel Klink's picture

Yields aren't reacting because the feral Fed and corrupt government are stuck in a coffin corner of their own making.

Eahudimac's picture

As long as Belgium is buying, the carry trade will live on. 

TruthDecalscom's picture

Saying the Obama Economy is Recovering is like Looking at a Cold Corpse and Saying "I Saw a Toe Wiggle."

Declare War on Political Correctness!   

The Most Interesting Frog in the World's picture

So the economy is doing great... the stock market will do great... bonds will go down...

Didn't I already hear that on CNBC?