I have a few questions on the economic cycle between bonds and equity?

Discussion in 'Economics' started by new0214, May 11, 2009.

  1. new0214


    When eco is under pressure, inflation is low, the government tries to revive it by cutting Interest Rates. So obviously there will be bidding for bonds which were taken at higher Interest Rates and bond prices will rise, and yields will fall.

    Q1 - The Fed has a measure of pushing the call rate below reverse repo rate to create more Liquidity. Exactly what does this mean.

    Q2 - More liquidity means I rates will remain low only, so I assume there is still demand for the 7 % Bond. Can you tell me the exact relationship between Liquidity generation and the resulting movement in the bond market ?

    Q3 – Expectation of recovery in equity keep bond markets up. Why does this happen ?

    Q4 – But Once the economy starts booming, inflation will go up and bond markets will fall. Why does this happen ?

    Q5 – So am I to understand that the bond market peaks out before the equity market.
  2. hi no one else seems to be giving you an answer so i will have a go. your questions are related to the bond market and interest rates and although i will not answer them individually i will explain why certain things happen with bonds when interest rates are changed.

    first of all the interest rate change in itself is made through other tools. three main ones the open market operation, the reserve mechanism and the discount flow window. these mechanisms work by buying up or selling assets most of which are bonds increasing or decreasing the liquidity.

    thus the interest rate itself is not the proponent it is the tools used to set the interest rate. the discount flow window for example is when the price is discounted or increased on bonds to alter liquidity this is the reason interest changes have a relationship with bonds due to the tools used to set the interest rate being related to bonds. as i am sure you know from the questions you have put there is a converse relationship with interest rates and bonds as a result of the mechanism used to set the interest rate.

    if you want to know more about this then look at a central bank website for papers. the transmission mechanism would be a good place to start it explains the affects and implementation of a interest rate alteration.
  3. I would not want to buy bonds today. What happens when inflation kicks in 3-4 years from now.

    Not an expert but bonds are priced an amount of basis points over the comparable treasury. the spread is determined by risk. so higher risk more points over the treasury.

    so if inflation hits then treasury yields have to go up which means new bond issues have to pay more and older bonds have to sell under par before maturity when they get traded.

    anyhow I might be wrong.
  4. i also wouldn't want to buy bonds, in england they had a strike on gov bonds so looks like no one else does either. this is worrying due to the gov needing funding through recessions but the ability to get the funding is diminished and less beneficial.
  5. You don't want to know the gory details of how the money mkts operate, trust me... Suffice it to say that the above means that the Fed has a particular way of pumping cash into the system.

    A stable relationship doesn't really exist. Liquidity generation is neither here nor there.

    That happens because the equity mkt pick up suggests more confidence in the economy, which suggests that the economy will do better. That helps the bond mkts, because govts/corps will not have to raise as much capital through issuing bonds.

    Inflation makes holding fixed income product more pointless, since your fixed interest income is worth less with every passing day. Therefore, investors will demand a higher yield upfront to hold bonds.

    That's the bazillion dollar question... It all depends on what the economy does next.