Interest Rates, i.e. Yields, Are Based Mostly on Demand

In my morning readings, I came across this post from Bloomberg about Chinese bond issuers facing troubles.  The headline reads:

China Set for Record Defaults, and Downgrades Tip More Pain

Key takeaway:

“rising yields are set to make the refinancing of maturing debt all the tougher for private companies that lack the access to the state-dominated banking system that national behemoths enjoy.”

What does this have to do with anything, you may be asking? Well let me answer that question with one of my own.  What causes yields to rise???

If you said a shrinking demand for the debt that is already out there, you should be a money manager.

But next we’d need to answer this question…Why is demand shrinking?

Because investors don’t believe the bonds will be repaid. Thus the supply of bonds being sold is increasing as current investors try to get out of their holdings but the demand is decreasing as few people want to buy them. Basic supply and demand economics. Higher supply and lower demand do what to prices? Yup, drop them.  Lower prices do what to CURRENT yields? Yup, raise them.

hmmm…sound familiar? In 2007 and 08 that’s exactly what happened here in the good ole US. There was no demand for any bonds other than government. (Warren Buffet being one of the exceptions.  He was on the prowl for buying cheap, cheap debt with his immense cash holdings.  Please learn from him and realize that cash IS an asset class).

Prices drop, yields go up.

With the US currently paying rates significantly higher than other countries, and I mean WAY HIGHER, decreasing demand is not a problem we face.

I am generally not the biggest fan of bonds. Simply because after taxes and inflation you are losing purchasing power.  But the bond market dwarfs the stock market and for your own financial management it’s good to have an idea of what’s going on out there.

Right now the US 10 Year is at 2.84%.  Could it go back to its normal 6% or so.  Sure.  Will it?  One would need to answer what would cause the demand of US debt to drop soooo much that rates would rise that much.

Hard to see that happening anytime soon.

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