We know that bonds tend not to have the suave or sexiness of equities and crypto. They are just boring interest rate products, right? Well, bonds wield far more influence on global markets than you may realise; they have been the main weapon used by Central Banks globally in 2020 and 2021 in fighting COVID’s impact on economies.
In the peak of the COVID crisis, when economies globally went into hard lockdowns for weeks and in some places even months, Central Banks raced to keep money moving through economies. The quick solution? Printing more money and use that money to purchase newly issued Government Bonds.
What does printing money do?
Central banks have been money printing to increase the flow of money through economies ever since the late 1970s. Often money printing is used to directly purchase new bonds, known as Quantitative Easing (QE), with the direct impact of being able to control the prevailing yield of these bonds. This is a bit technical, but if a Central Bank is using its function to be in an economy creating more bonds, and buying the existing supply of bonds, it has the effect of forcing bond prices higher, and lowering the effective interest rate each bond yields.
The RBA, ECB, Federal Reserve, the Central Banks of Australia, the EU, and the USA , all have active bond buying programs ongoing in mid-2021, where more and more money is flowing into these respective economies. Japan has been doing it for many years to manage its economy.
What effect does this bond buying have on economies?
With the continual supply of money and bonds in global economies, the cash rates have remained exceptionally low, near zero rates in many major economies, to the extent that this continues to force investors to choose if they want to put their money in bonds and bank accounts that yield very low interest rates, or invest in other assets like equities, commodities, real estate or crypto.
What may cause Central Banks to change their policies of money printing?
The “i” word. Inflation. Some economic theories predict that if there is too much money in an economy it will force prices of goods and services broadly higher, especially food and essential services like energy and utilities. In this case an economy can be said to be “running hot” with growth, and Central Banks will often raise interest rates to slow down the growth pace and maintain the relative affordability of an economy. However, since the GFC in 2008, the printing of money has not caused economies to run hot.
The conundrum
If inflation starts to appear in economies at the exact same time as these aggressive bond buying programs, a Central Bank is forced to make a decision. Does it slow or stop bond buying, which often has the effect of raising yield curves and interest rates within an economy, or does it keep buying bonds and hope the inflation disappears? This is the precise crossroads the Global Central Banks have reached.
Inflation is rising in Australia, and even in the US. The NZ Central Bank is already talking about an interest rate rise in 2022, and the US Fed Reserve is now starting to consider the possibility that the Bond buying program will eventually get scaled back. This comes despite the US Fed describing recent inflationary reads as “transitory”, meaning they hope it will disappear without any intervention. But in the EU, the Central Bank suggests there is no inflation, and there was a sharp rise in Bund prices (German Bonds) in late May, which has the effect of lowering interest rates even further. Central banks seem to have learnt their lesson from the GFC, where they stopped bond buying too early, and they will now let an economy run hotter and longer before interest rates begin to rise.
What effect does this have on other assets, like equity ETFs, real estate and crypto?
These bond buying programs have caused a sharp increase in the prices of assets, such as equity ETFs, real estate and crypto. It has also meant that bond prices globally have remained elevated, supported by these programs. With no Central Bank in a position to be willing to switch off their programs, there are less catalysts to cause a sharp downward correction in equity prices. This is why despite bonds seeming like quite a boring asset class, they wield such a mighty influence on the asset prices in our economy.
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