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The Bond Bubble Collapse Thread; Reset Time. This is the End of the Line for All the Rolling Bubbles Propped Up in the last 30 Years
Topic Started: 21 Aug 2016, 04:02 PM (11,436 Views)
Jon Snow
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b_b
18 Sep 2016, 06:13 PM
Only if you borrowed and lent floating. But it is pretty easy for a large financial insto (ie a bank) to borrow and lend fixed to match the FX hedge settlement. Remember lending fixed is no different to buying a government bond with the desired maturity.

Edit: Now there is duration risk...but that is pretty small and the scheme of thing and will be more than covered by the bank fee / margin etc.
And if the counterparty falls through, the bank is now exposed to FX risk.

i.e. if the exchange rate goes below 0.9545, and the sale of widgets falls through, the bank has an FX exposure.

It's only credit risk up until the point where the counter party defaults. After that it becomes market risk.

And ..

Government bonds are at fixed maturities. Fixed lending is almost always done with swaps for this reason. Fixed-fixed are just currency swaps with an agreed margin.
Edited by Jon Snow, 18 Sep 2016, 07:55 PM.
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b_b
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Jon Snow
18 Sep 2016, 07:51 PM
And if the counterparty falls through, the bank is now exposed to FX risk.

i.e. if the exchange rate goes below 0.9545, and the sale of widgets falls through, the bank has an FX exposure.

It's only credit risk up until the point where the counter party defaults. After that it becomes market risk.

And ..

Government bonds are at fixed maturities. Fixed lending is almost always done with swaps for this reason. Fixed-fixed are just currency swaps with an agreed margin.
What you describe is No different to any other banking function. Lend against a house and if the borrower goes bad the bank has market (property) risk.

So my point stands. With fx hedging it is about credit (counterparty) risk. Remember this discussion started because someone else stated once the aud falls no one will provide currency hedges. That is simply not true.

And I'm sorry I have to disagree with your second point. Banks borrow term all of the time (bank bond issuance). They can also borrow term in the interbank market.
(S – I) + (T - G) + (M - X) = 0
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Jon Snow
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b_b
18 Sep 2016, 10:20 PM
What you describe is No different to any other banking function. Lend against a house and if the borrower goes bad the bank has market (property) risk.

Right, but I wasn't the one claiming that the bank could buy a mortgage without exposing itself to the property market.
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So my point stands. With fx hedging it is about credit (counterparty) risk. Remember this discussion started because someone else stated once the aud falls no one will provide currency hedges. That is simply not true.
They did? I need to go back and see what was actually claimed.
Do you mean this?
Quote:
 
If the the Aus dollar tanks, bond investors will be wiped and no amount of currency hedging can make up for the losses.

or this?
Quote:
 
The writing's on the wall. Nobody will insure the Pacific Peso for less than 1.5 points. Too much risk, interest spikes and Aussie crashing, over a 30 year bond. The hedge fund that insures it would probably have gone bankrupt anyway by the time anyone stupid enough to buy Aus treasuries makes the claim.


Actually, I'm not exactly sure what the second quote means.

At any rate, hedging can only save your position if you have the hedge ON when your position craters. Given the cost of hedging, it's likely that most exposures are unhedged.

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And I'm sorry I have to disagree with your second point. Banks borrow term all of the time (bank bond issuance).

Domestically sure. I thought we were talking about x-ccy.

Quote:
 
They can also borrow term in the interbank market.
Domestic and BBSW is all short dated (6M and shorter), which means you are still exposed to basis risk.
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b_b
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Jon Snow
19 Sep 2016, 12:41 AM
Right, but I wasn't the one claiming that the bank could buy a mortgage without exposing itself to the property market.







Neither was I. I was simply saying that a bank can provide a currency hedge without exposing itself to currency risk. You said you were interested in knowing what I meant. So I posted. You then suggested if the counterpart fails the bank will have fx (mkt risk), which is true, but that is no different to any other bank credit decision. There is always an underlying market risk if they credit goes bad. But that was not the initial context of the discussion.
Quote:
 
At any rate, hedging can only save your position if you have the hedge ON when your position craters. Given the cost of hedging, it's likely that most exposures are unhedged.

Well the cost of the hedge is the difference in IR’s, plus fees etc. Investors may use FX hedging to de-risk aussie bonds, because even though the lose the benefit of a higher rate (via hedge costs) they may feel they are getting better credit (AAA).
Quote:
 
Domestically sure. I thought we were talking about x-ccy.

We are talking about x-ccy. So a bank can get fixed funding domestically (MTM’s) or internationally (see link). As discussed, this type of funding can help cover the net exposure of the FX hedge book without the basis risk to which you referred.
http://marketrealist.com/2016/08/westpac-banking-issued-the-most-high-grade-bonds-last-week/
Quote:
 
Domestic and BBSW is all short dated (6M and shorter), which means you are still exposed to basis risk.

True - but a large % of FX hedging is 6 months or less anyway. For longer dated hedges banks turn to term funding domestically or internationally.

So my point stands. The hedge provider will not “go broke” just because the “pacific peso” crashes especially if the collateral is a sovereign issued bond. Currency hedges can be put in place without the Bank “punting” on the currency as I have now demonstrated. So long as they get they credit right, there is no market risk.
Edited by b_b, 19 Sep 2016, 04:09 AM.
(S – I) + (T - G) + (M - X) = 0
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Jon Snow
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b_b
19 Sep 2016, 03:51 AM
Neither was I. I was simply saying that a bank can provide a currency hedge without exposing itself to currency risk. You said you were interested in knowing what I meant. So I posted.
And I appreciate you posting.
Quote:
 
But that was not the initial context of the discussion.
It's still not entirely clear to me what the context was/is.

Quote:
 
Well the cost of the hedge is the difference in IR’s, plus fees etc. Investors may use FX hedging to de-risk aussie bonds, because even though the lose the benefit of a higher rate (via hedge costs) they may feel they are getting better credit (AAA).
Interest rate parity should mean that there is no arbitrage in pure FX/credit positions. The only point of carry trade would be to borrow in an IR stable currency and lend in an IR volatile currency.

Quote:
 
We are talking about x-ccy. So a bank can get fixed funding domestically (MTM’s) or internationally (see link). As discussed, this type of funding can help cover the net exposure of the FX hedge book without the basis risk to which you referred.
http://marketrealist.com/2016/08/westpac-banking-issued-the-most-high-grade-bonds-last-week/

Well, there is $1B of basis risk in there:
$500 million in three-year FRNs (floating-rate notes) issued at LIBOR (Intercontinental Exchange London Interbank Offered Rate) + 56 basis points
$500 million in five-year FRNs issued at LIBOR + 85 basis points

Westpac must not be expecting US rates to move any time soon. And why would you.

Quote:
 
So my point stands. The hedge provider will not “go broke” just because the “pacific peso” crashes especially if the collateral is a sovereign issued bond. Currency hedges can be put in place without the Bank “punting” on the currency as I have now demonstrated. So long as they get they credit right, there is no market risk.
I'm not convinced there is no basis risk in your illustration. And large FX movements can lead to credit contagion. However I am willing to leave it at that.
Edited by Jon Snow, 19 Sep 2016, 08:34 PM.
Speak when you are angry and you will make the best speech you will ever regret.
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Terry
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Jon Snow
19 Sep 2016, 08:33 PM
And I appreciate you posting.

It's still not entirely clear to me what the context was/is.


Interest rate parity should mean that there is no arbitrage in pure FX/credit positions. The only point of carry trade would be to borrow in an IR stable currency and lend in an IR volatile currency.



Well, there is $1B of basis risk in there:
$500 million in three-year FRNs (floating-rate notes) issued at LIBOR (Intercontinental Exchange London Interbank Offered Rate) + 56 basis points
$500 million in five-year FRNs issued at LIBOR + 85 basis points

Westpac must not be expecting US rates to move any time soon. And why would you.


I'm not convinced there is no basis risk in your illustration. And large FX movements can lead to credit contagion. However I am willing to leave it at that.
Well you get sucked in right there. Of course, IRs and banks don't carry currency risk when when hedging AUD denominated bonds. Complete non-issue for the sake of a sermon.
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createdby
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Some listening while we await Kuroda and Yellen news.

"When the bond market breaks, when that bubble bursts, it will wipe out every asset. Everything will collapse together...everything is geared off of that so-called risk-free rate of return. And if your risk-free rate of return has been (?) down to zero percent for 96 months, then everything, everything, I mean diamonds, sports cars, mutual funds, municipal bonds, fixed income, REITs, collateralised loan obligations, stocks, bonds, everything, even commodities, will collapse in tandem along with the bond bubble burst."


https://www.youtube.com/watch?v=IAiQTcmc_Hg

Edited by createdby, 21 Sep 2016, 09:58 AM.
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Terry
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createdby
21 Sep 2016, 09:57 AM
Some listening while we await Kuroda and Yellen news.

"When the bond market breaks, when that bubble bursts, it will wipe out every asset. Everything will collapse together...everything is geared off of that so-called risk-free rate of return. And if your risk-free rate of return has been (?) down to zero percent for 96 months, then everything, everything, I mean diamonds, sports cars, mutual funds, municipal bonds, fixed income, REITs, collateralised loan obligations, stocks, bonds, everything, even commodities, will collapse in tandem along with the bond bubble burst."


https://www.youtube.com/watch?v=IAiQTcmc_Hg

Like many people involved in money markets feel, Pento argues that central banks should have allowed house prices and stock prices to crash in 2008. take their natural course during the financial crisis.

"If we allowed markets to repair themselves in 2008, in other words, if we allowed home prices to fall and, stock prices to fall and interest rates to rise, and debt levels to contract, then we would have had a depression for a few years, at the most.

"But then we would be able to come out of that with stable money supply, stable interest rates, stable currency, low debt to GDP ratios, high productivity rates, massive capital expenditures, and a nice healthy growing economy."


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createdby
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Terry
21 Sep 2016, 10:40 AM
Like many people involved in money markets feel, Pento argues that central banks should have allowed house prices and stock prices to crash in 2008. take their natural course during the financial crisis.

"If we allowed markets to repair themselves in 2008, in other words, if we allowed home prices to fall and, stock prices to fall and interest rates to rise, and debt levels to contract, then we would have had a depression for a few years, at the most.

"But then we would be able to come out of that with stable money supply, stable interest rates, stable currency, low debt to GDP ratios, high productivity rates, massive capital expenditures, and a nice healthy growing economy."

Crashing is just the value of something going to zero.

Well, let's just use a negative value for our money then.

So that zero is now "positive" relative to negative.

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Terry
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createdby
21 Sep 2016, 12:19 PM
Crashing is just the value of something going to zero.

Well, let's just use a negative value for our money then.

So that zero is now "positive" relative to negative.

Pento is a media whore to some extent, but his position resonates well with many on the "inside". By that, I mean those who play play the game on the institutional side. I kind of agree that the world would have been better off to let it all side in 08. Because as Pento alludes to, the leverage of the markets and monetary system now make 08 seem like a Walt Disney film from the 60s.
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