Where Are Supply/Demand Curves?

The reduction of the Fed’s balance sheet is coming, and so we are likely to be involved in debates about how much this will affect bond yields. I am in the camp that the quantities involved do not really matter (which some qualifications). I just want to explain my logic, which involves discussions about “supply and demand” curves for bonds, which vary based on time frame. Although this discussion might appear obvious, my feeling is that there are some hidden assumptions that people make about market price determination.

Higher Debt-To-GDP Ratio And Lower Bond Yields: Japanese Experience

I recently referred to an older article in which I showed how higher debt-to-GDP ratios for the U.S. Federal Government was correlated with lower bond yields. The post-war U.S. experience was not an isolated case; similar relationships hold for the countries with free-floating currencies. The Japanese Government Bond (JGB) market is the poster child for this correlation.

Why China Should Become A Corporate Bond Dealer

In this latest "Stuff I Read On The Internet" entry, I look at two complementary posts on supply and demand issues in the bond market.

• In "Who's Afraid Of China?", Paul Krugman discusses the fears associated with China's massive Treasury bond holdings, and shows why they are not a worry. See the discussion on Mike Norman Economics with regards to how his taking the view of the dominance of rate expectations is a move closer to the MMT theoretical position (and mine).
• In "The Looming Bond Fund Crash", Paul Amery discusses the vulnerabilities noted by Citi Credit Strategist Matt King that are allegedly created by the shrinking dealer inventories of corporate bonds.

The win-win solution is obvious: the Chinese government should become a market maker in corporate bonds. They can easily ramp up their corporates inventory, and they can diversify their USD exposure away from Treasurys.

What Is A Government Bond?

This primer answers the question “What is a government bond?” is in terms of defining what a bond does. The answer is that a government bond is an instrument that drains reserves from the banking system. This is not the standard way of looking at government bonds, but I believe it is the key ingredient explaining why the rate expectations theory provides the best description for bond market pricing. (Note: this analysis does not apply to sub-sovereign governments, like Provinces, States or Municipalities.) One can equivalently say that bonds are "forward money".

Note that I am not discussing the legal/financial structure of bonds, I will eventually write a primer on that topic.

Higher Debt-to-GDP Means … Lower Bond Yields?

This article addresses one issue regarding Fed “Tapering” (reduction of bond purchases, or Quantitative Easing (QE)) that I had not previously discussed: the impact of Fed purchases on bond yields. To recap my earlier article, I argued that QE had no impact on the economy as a result of the change of size of the Fed’s balance sheet. But did QE lower bond yields as a result of the increased demand for bonds? In this article, I begin to outline why I think supply and demand factors have limited impact on the level of bond yields.