This is a sequel to our earlier post What’s The Yield Curve Saying About Asia And The Bubble Cycle?, but this time in graphs.
The idea is that steep yield curves emanating from central bank policies incentivize the market to engage in various interest rates arbitrages like carry trades, stock market speculations and other borrow-short-invest-long transactions which essentially fuels bubble cycles.
A reminder is that interest rate policies and the shape of the yield curves impact the asset markets with a time lag. Said differently, asset markets respond to rate curves belatedly.
As earlier shown, in the US yield curve has been extraordinarily steep which most likely implies strong support to her asset markets. Importantly, because the US government has reflating its banking system, the arbitrages are likely to support global markets more as investors seek to optimize returns at the long end.
This means that the US dollar carry trade is likely to inflate further. And carry trades aren't likely to be confined to the US dollar but diffused to major currencies which have all engaged in competitive devaluation via a combination of suppressed interest rates, fiscal spending and most importantly, quantitative easing programs.
In addition, because asset market reflect a time lag on the curve, credit systems hobbled by deleveraging (such as in the US, UK and parts of Europe) could probably see belated marginal positive responses or improvements but would not likely reach the level it had during the last boom.
It is in Asia and emerging markets where a credit fueled bubble cycle is likely to take place.
In Asia where low interest rates have generated more policy traction than in crisis affected Western developed economies, the yield spreads also remain elevated.
And as earlier pointed out, combined with the other policies all these have been manifested in asset outperformance.
Again the steepness of the yield curve in the region should lend support to the asset markets for the meantime. As local investors and speculators and the domestic financial institutions will be incentivized to take advantage of the wide chasm in interest rates.
The following charts are all from Asian Development Bank's Asianbondsonline.com.
The idea is that steep yield curves emanating from central bank policies incentivize the market to engage in various interest rates arbitrages like carry trades, stock market speculations and other borrow-short-invest-long transactions which essentially fuels bubble cycles.
A reminder is that interest rate policies and the shape of the yield curves impact the asset markets with a time lag. Said differently, asset markets respond to rate curves belatedly.
As earlier shown, in the US yield curve has been extraordinarily steep which most likely implies strong support to her asset markets. Importantly, because the US government has reflating its banking system, the arbitrages are likely to support global markets more as investors seek to optimize returns at the long end.
This means that the US dollar carry trade is likely to inflate further. And carry trades aren't likely to be confined to the US dollar but diffused to major currencies which have all engaged in competitive devaluation via a combination of suppressed interest rates, fiscal spending and most importantly, quantitative easing programs.
In addition, because asset market reflect a time lag on the curve, credit systems hobbled by deleveraging (such as in the US, UK and parts of Europe) could probably see belated marginal positive responses or improvements but would not likely reach the level it had during the last boom.
It is in Asia and emerging markets where a credit fueled bubble cycle is likely to take place.
In Asia where low interest rates have generated more policy traction than in crisis affected Western developed economies, the yield spreads also remain elevated.
And as earlier pointed out, combined with the other policies all these have been manifested in asset outperformance.
Again the steepness of the yield curve in the region should lend support to the asset markets for the meantime. As local investors and speculators and the domestic financial institutions will be incentivized to take advantage of the wide chasm in interest rates.
The following charts are all from Asian Development Bank's Asianbondsonline.com.
Thailand
Finally, it would be foolish for anyone to think that stock markets move in a straight line, because in reality they don't.
Nevertheless, any attendant weaknesses should be construed as countercyclical or temporary events because aside from many other factors, steep yield curves are likely to support credit activities that should work favorably for asset markets.
Emerging Market guru and Franklin Templeton's chief honcho Mark Mobius nails it when he recently wrote, ``what I said was that in a bull market as we are now experiencing, there will be corrections as the market continues to march upwards, and such corrections could be anywhere from 15 to 20%, or even 30%. We have to be ready for such short-term volatility. The markets in China, Asia, and Dubai have seen corrections of 20% or more during the recent crisis, so these kinds of corrections should not be surprising.I want to emphasize that I am not predicting any specific correction but I am just saying that we have to prepare for such corrections and that we not be alarmed by them given current market conditions. Overall, I believe we will continue to see markets rise in the long run." (bold emphasis mine)
In short, market operates in cycles.
Finally, it would be foolish for anyone to think that stock markets move in a straight line, because in reality they don't.
Nevertheless, any attendant weaknesses should be construed as countercyclical or temporary events because aside from many other factors, steep yield curves are likely to support credit activities that should work favorably for asset markets.
Emerging Market guru and Franklin Templeton's chief honcho Mark Mobius nails it when he recently wrote, ``what I said was that in a bull market as we are now experiencing, there will be corrections as the market continues to march upwards, and such corrections could be anywhere from 15 to 20%, or even 30%. We have to be ready for such short-term volatility. The markets in China, Asia, and Dubai have seen corrections of 20% or more during the recent crisis, so these kinds of corrections should not be surprising.I want to emphasize that I am not predicting any specific correction but I am just saying that we have to prepare for such corrections and that we not be alarmed by them given current market conditions. Overall, I believe we will continue to see markets rise in the long run." (bold emphasis mine)
In short, market operates in cycles.
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