Friday, May 23, 2014

Financial Comment - Hot money fuelling bonds

Hot money keeps fuelling bonds

For five years now, it is viewed by many that the accommodative monetary policies of U.S. and Canadian central banks has been a major reason for the strong performance of stocks. American stocks are posting new historic highs this year, while Canadian stocks are reaching their pre-crisis highs. The bond markets are also flush with liquidity and bond yields are declining. Year to date, the 10-year U.S. Treasury bond’s yield dropped by 40 basis points to about 2.60% while the 10-year Government of Canada yield dropped by 60 basis points to about 2.30%.

This trend has spilled over to the speculative grade (high-yield or junk) bond market. According to Bloomberg and Barclays Plc, investors are earning very little extra yield on smaller and riskier American bond issues as compared to lower-risk, bigger issues: the yield gap between them has collapsed from 1.05% in late 2011 to almost zero. This process is not without positives for the real sector of the economy: Bloomberg reports that it has become much cheaper to finance smaller companies and in particular their M&A activity with bond issues as investors added $230 million to high-yield focused mutual funds in April, according to the Investment Funds Institute of Canada.

So far, the long period of easy monetary policy has lead to more aggressive financial activity, while capital investment and economic growth remain moderate in both Canada and the U.S. Over the next while, it will become more clear whether the recent decline in bond yields is a precursor of more trouble for the economy or cheaper money will find its way into the real sector and bring about economic growth.

By: Ukrainian Credit Union Limited

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