Thursday, December 13, 2012

How US Federal Reserve Policies Linked the Bond Markets with Equity Markets


Fed policies have enormous impact on the financial markets. Part of this has been to interlink the actions between the bond and equity markets. Perhaps this could be part of the US Federal Reserve Chair Ben Bernanke’s Portfolio Balance channel or “once short-term interest rates have reached zero, the Federal Reserve's purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public.”

At his blog, Dr. Ed Yardeni explains (bold mine)
The bond cult is dominated by individual and institutional investors desperate to get some yield north of zero on their fixed-income investments. This is most evident in the monthly mutual fund data compiled by the Investment Company Institute. Over the past 12 months through October, net inflows into bond funds totaled $392 billion; equity funds experienced an $80 billion net outflow. Since the start of the latest bull market in stocks during March 2009, net inflows into equity funds was virtually zero, while bond funds attracted $1.25 trillion.

Nonfinancial corporations have been borrowing money from the bond cult, whose members have been desperately scrambling to lock in yields as the Fed has driven them closer to zero. Over the past four quarters, mutual funds purchased $267 billion in corporate and foreign bonds. To the extent that some of these funds have been used to buy back shares, the bond cult has been financing the bull market in stocks. This was all masterminded by the Fed’s equity and bond cults and implemented with their NZIRP and QE programs.
Such relationship partly explains the Risk ON-Risk OFF scenarios, as well as the current recovery in US housing

The bottom line is that asset markets have become immensely interdependent with each other that enhances the risks of contagion. 

Oh you can bet that such interrelationships have not just been limited to the US but to the world.

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