Another Bubble: G-Secs This time

Recently as the Federal reserve has cut the target rate to close to zero. The shot term treasury bond in US has jumped to record high levels. Govt. securities because of the backing of government assures investors that they will get their money back. Yields on these shot dated T-bill has gone very close to zero and there were cases where the value of these bonds had gone up over face value of 100. Meaning they were actually yielding negative returns.

Such surge in the govt. bond prices has created "bubble" in the government T-bill market. A security which was considered too boring compared to exotic real estate and credit linked bubbles we have had in past.

One thing is for sure that the previous bubbles were also caused due to ridiculously low interest rate targets set by Greenspan in early and mid part of this decade. What followed after the bubble was something that had impact over economies throughout the globe.

Are we going to face another bubble again stirred off by the Federal Reserve? and in which market is this new bubble going to burst? Treasury Bills? Maybe its too early to take a call, but never forget that the earlier bubbles were equally nascent and not spotted off early.

Focus: Fed Funds Rate

Everyone in the market is expecting a cut in the target fed funds rate by Federal Reserve. This is the rate that Federal Reserve will try to achieve in the inter-bank borrowing market in US.

The futures on the t-bills can provide indicative market sentiment and expectations towards changes in future rates. The option contract on t-bills futures on C-bot (Chicago board of trade) can even provide the probability how much the market is pricing in a rate cut. Assuming there is a close relationship between fed funds rate and t bills rates.

If federal reserve cuts rates below to below 50bps then that will be the lowest rate since world war 2. Already market expectation of 75 bps cut was showing a probability of close to 90% week back, but one day before the cut has come down to 50-60%. What is more shocking that there is a 20% probability that the federal reserve will cut the Fed funds rate down to 0%. The effective federal funds rate on the futures market has fallen near zero as well -- as low as 0.0625 percent -- despite the Fed target of 1.0 percent.

Rate cuts do boost the economy, but there are times when rate cut do not really lead to economic growth, this is due to deflation (-ve inflation). During times of deflation even though the interest rates might be close to zero but real interest rates which is the difference between interest rates and inflation could end up being really high, making borrowing less attractive. At the same time there is a decline in the investments due to negative time value to money; money in future is more valuable that money now, so by just keeping money idle under the bed would generate a return!

The rate cut I believe is just a cosmetic measure to be taken by Federal Reserve even though it is occupying lot of media space. What I believe is more important are the measures to be taken by the government to boost spending and economic growth. That would be the true solution to the worst global economic period since great depression!

Mkts Wait for i-rates

It is going to be another busy week for traders and analysts, because of the central banks of key economies are about to unveil their policies related to interest rates. US Federal Reserve Chairman Ben Bernanke is expected to release its comments on Wednesday. The Bank of England and the European Central Bank will also come up with its view on interest rates. Widely it is expected that the Bank of England will raise its interest rates by 25 basis points to curb the inflation. On the other hand US and the ECB is expected to keep its rates untouched.

The next two three days are going to be very exciting. In case if the things don’t go as expected then the markets make take a big hit. Already the Dow is at new all time highs and so are the indexes at other countries like the French CAC.

Indian markets are also showing a similar trend. The Nifty is still hovering above 4000 points. In this market global markets are going to have a significant impact. Keep watching this space for more articles on Interest rate policies and its affect on markets.

Global Hedge Fund Alert!

The New York Federal Reserve gave an alert on accumulated risks created by the growing Hedge Funds. They concluded that this could be the biggest threat to the financial world since the fall of LTCM (Long term Capital Management). LTCM was a Hedge fund founded on the shoulders of mathematical / Economic geniuses, Robert C. Merton (and Myron Scholes (who won Nobel Prize in 1997.

LTCM took full advantage of leverage and used its size to create a huge diversified portfolio. During the 1998 economic turmoil their funds lost the diversification advantage and this resulted in a highly correlated portfolio. In the end within months the whole fund collapsed and in the end the Federal Bank of New York had to step in with support of close to $ 4 billion to stop a “systemic fall” of the financial markets.

The Federal Reserve of New York compares the current scenario of Hedge funds with the LTCM crisis. The Hedge funds are showing a huge correlation in their returns, predisposing the markets to a “systemic downfall.” The total size of the Hedge funds now stands at $ 1.4 trillion, larger than many economies of the world. The funds are now betting aggressively with fewer strategies and by taking higher leverage through use of derivatives.

Interest Rates Rising

US FED Reserve had been constantly hiking interest rates due to high inflation fuelled by the heating up of commditities prices. And Globaly central banks were trying to match US FED by doing the same. In India also RBI started taking a harder stance by revising the REPO and Reverse REPO rates. Last month the rates were increased by 25 basis points. This has lead to increase in the cost of borrowings of commercial banks who are passing this on to their clients by revising their lending rates.

It is quite evident that since the rate of interest goes higher it will impact the sectors of economy that are dependent on interest rates, like the housing sector. To some extent the housing real estate boom in India was related to the cheap housing loans offered by banks. Still finace minister P Chidambaram believes that the interest rate hike is very moderate and it will not affect the booming housing sector.

The government is trying to do its best to not allow the interest rates to hamper the growth of our economy. The cost of borrowings of the Indian companies has increased in recent times which might affect profitability. The govt. is trying its best to keep a balance by hiking the interest rates to control inflation (abt 5%) and at the same time trying to keep the cost of borowings down by infusing liquidity through reduction of CRR ratio to 5%.

It is very clear that the govt. supports high growth rate of GDP, and in order to maintain this they are trying to keep cost of borrowing low. They are also asking the PSU banks to not hike their PLR(Prime lending rates) in accordance with the market.