Did fearful investors suddenly shift from holding 2-year corporate bonds to holding T-bills, thereby driving down the price of these corporate bonds and, equivalently, driving up their effective yield? Such a move might seem compatible with the onset of regime uncertainty.
But the relative steadiness of the yield on longer-term corporates is not consistent with this view.
Why would investors fearful of regime change leap out of only the relatively short-term corporates, not the longer-term corporates as well? I am puzzled.
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A friend and I are thinking there was a massive sell-off of short-term corp. bonds. Hedge funds, mutual funds etc…needed capital so they liquidated, driving the 2 year up. There’s a strong chance these firms weren’t holding as many long term bonds, which would explain why the long terms didn’t jump.
Fiat Money Inflation in France by A.D. White
http://www.literaturecollection.com/a/andrew-dickson-white/fiat-money-inflation/3/
Several possibilities come to mind. First, there may be a different mix of sectors at the different maturity points. For instance, 2-year debt might be weighted more heavily to financial issuers which were quite risky post-Lehman and pre-government guarantees. Second, the mix of company maturity structures might be different. For instance, the 2-year debt might be primarily issued by companies with heavy maturities in 2010 and the market may be judging them to be at risk of not being able to refinance their debt in 2010. Third, 2-year debt may be a proxy for dramatically increased risk aversion in the short term market as money funds sold to accommodate investor demands for t-bills after the Reserve Fund broke the buck. Also, I recommend you look at CDS spreads as they are far more liquid and have been generally leading cash bond spreads. However, CDS spreads are likely harder to get than cash bond spreads
That is an interesting anomaly. I was looking at similar anomalies in yield spreads recently, working on a theory of self-fulfilling liquidity crises, and suddenly realised I was re-inventing Carl Menger’s theory of the origin of money!
http://worthwhile.typepad.com/worthwhile_canadian_initi/2008/12/trading-volume-and-financial-crises.html
Suppose that 2-year corporate bonds are more liquid than 5-year corporate bonds, and so have a lower yield in equilibrium. Then the market in corporate bonds dries up, so they become less liquid. This has a bigger impact on 2 year bonds, since the people holding them valued liquidity.
But it’s hard to explain why holders of the 5 year bonds did not sell them, and buy 2 year bonds instead, when the 2 year yield went above the 5 year yield. Maybe it was fear that the 2 year bonds could not be rolled over, and the companies issuing them would themselves suffer a liquidity crisis.
Could it be that these graphs are comparing apples to oranges?
Is it possible that the long term bonds are from companies with better balance sheets than the short term bonds?
There would seem to be an incentive for “high grade” companies with questionable balance sheets to use the short term bond market over more profitable, and stable, “high grade” companies. This would explain why the long term rates didn’t jump with the short term rates – it’s because they are actually different goods from different companies.
Now if someone can find a single company where their long term rates are less than their short term I will concede that this explanation is not satisfactory.
Casey,
Does that count Treasuries,….20 and 30 years….
I believe alot of fund managers, who held a lot of 2 year bonds, needed cash, and sold the 2 years. Your talking about 2 months the yield was inverted.
Casey,
Does that count Treasuries,….20 and 30 years….
I believe alot of fund managers, who held a lot of 2 year bonds, needed cash, and sold the 2 years. Your talking about 2 months the yield was inverted.
The demise of several large investment banks that “made a market” in these bonds, along with the fact that the surviving traders probably became rather timid, is likely to have significantly reduced the liquidity of the market for the 2-year bonds, which at a time of significant selling would explain the spike. As to why other maturities weren’t similarly affected–I dunno?
There’s an interesting correlation, only one month appart with the leveling off of government paper reserves.
http://www.plata.com.mx/mplata/articulos/articlesFilt.asp?fiidarticulo=89
They rose rapidly until august 2008 and then at just under 7 trillion the plateaued. A 90 degree turn form exponential growth to a slight downward trend. It too is perplexing but since the main player in paper reserves was China and it may be the actor here too. China is a huge sovereign wealth fund, with massive reserves of ‘socialist’ savings. It moved into the global paper reserves and bond market to sweeten several deals with the West including the Olympics. When the deals were in the bag and the games sealed and at delivery they pulled first their reserves demand, no one was watching the data. Then after the games they pulled out of 2 year bonds. The longer term bonds are unaffected because they knew the change in plan was pending so had not bought the longer term bonds. They could buy the 2 year bonds with less risk than 5 year bonds.
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