22 June 2022
The US Government bond yields have been rising over the last 6 months. The situation is getting worst; much worse than China's bond yield as shown in this attached chart. Is that a cause of concern or would traders ditch the US bond market for other markets?
Why the Concern?
Government Bonds are often seen as a safe-haven investment in the investing world. They play an important role because they will bring income, stability and diversification. But when there is a rising yield, the investors become worried because they will get less if they sell their bonds.
Why does the US's Yield Curve look that bad Today?
6 months ago, US's yield curve looked pretty good. It was much better & healthier than the Chinese yield curve. But that has been changed about a month ago when Fed announced that it would raise the Fed fund rate aggressively to curb inflation. This announcement and subsequent action by Fed in the following months have dampened the investors' sentiment. The investors are also worried about long-term growth caused by the rising Fed fund rate and the Quantitative Tightening (QT).
China has so far kept their bank lending rate steady. On some occasions, they even cut the bank lending rate to stimulate the troubled housing sectors.
How do bond yields impact the stock market?
Investors will always compare the returns and the risk premium when they buy any investment product, be it stocks or bonds or other financial instruments. When valuing equities, investors will add the equity risk premium and compare that to the rate of return from bond yields for example. If the bonds have better returns, they will dump equities and buy bond yields and vice versa.
Would Investors Ditch US Bond Market?
Some investors began to worry about the US Bond market when the bond yields turned bad recently. Some expected the investors will ditch the US bond market and prefer to buy other bond markets such as the Chinese bond market because the Chinese bond yields looked much better. Would this happen in the near future and why?
The answer is not definite; it would depend much on how much an investor needs to fork out to buy a Credit Default Swap (CDS) from the Derivative Market.
What is a Credit Default Swap (CDS)?
CDS is a financial derivative that the bond buyers will usually buy to offset the credit risk. Buying CDS is like buying an "insurance policy". The buyers will pay a premium. This is to ensure that they would be reimbursed in case there is a bond default. If the bond buyer is borrowing the money from the banks to buy the bonds, the banks might have a condition for the borrower to buy CDS before the banks give out the loan.
What are the CDS Rates Today?
CDS rates or premiums will be different for different Governments or Corporate bonds.
One can make reference to this quick list on this webpage for the latest quote on CDS rates for the Government bonds.
The following picture shows the 5-year CDS value for the US Government bond is 16.6 on 22 July 2022 and for China, it is 78.59. China has a higher CDS value because it has a higher probability of default at 1.31% based on a 40% recovery rate.
The quoted CDS value would be used to work out the premium to be paid by the CDS buyers. The higher the value will mean the higher the premium.
Therefore, it does not mean buying the Chinese Government bonds will be more cost-effective than buying the US Government Bond because the US yields are rising.
Reference:
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