Thread by @MacroAlf

As promised, here is the bond market 101 thread!

Answering the top 10 questions I received in a previous tweet, here we go!

1/10

Question #1: ''Why is 10yr not going up with Fed about to finish QE/star hiking/inflation printing high?''

A: 10y yields are roughly the sum of 10y real rates, 10y CPI expectations and term premium. When the Fed tightens, the medium/long-end of the bond market extrapolates lower nominal growth going forward (= lower rates) and more certainty about this outcome (= lower term premium)

Question #2: ''If CBs don't manipulate yields, then please explain the negative yields in Europe, thank you!''

A: Long-term drivers of interest rates are mostly labor supply growth (demographics), labor and capital productivity. All of the above have been trending down badly in Europe, and equilibrium real interest rates (black line) would be negative in many EU countries even without QE.

Question #3: ''Can you please provide an in-a-vacuum framework re how/why individual 2/5/10/30 curve points *should* respond to directionality of each primary driver (rates, inflation, growth expectation?)''

A: Front-end rates are more responsive to cyclical changes in real growth and inflation as those impact monetary policy decisions (repo also plays a very important role, will cover later). Long-end rates are more influenced by long-term real growth and inflation drivers.

Question #4: ''To what extent could studying the repo market & its mechanics in depth provide a significant edge w.r.t. trading bonds/rates, in your opinion?''

A: To a large extent! The repo market is the backbone of the fixed income market and it's largely underappreciated. Liquidity providers and risk-takers (hedge funds, bank dealers etc) fund basically all their position using the repo market - and still nobody talks about it.

Question #5: ''Why does everyone think they are smarter than the bond market?'' @SantiagoAuFund eheh :)

A: Because they don't understand how it works.

Question #6: ''What can be gleaned from the shape of the yield curve?''

A: A steep yield curve implies that market participants believe future growth and inflation are likely to be robust for a prolonged period of time and that monetary policy is (and likely to remain) easy for a while; a flatter yield curve means the opposite.

Question #7: ''Why is US 30y real yield negative? Why is US 30y nominal yield so low?''

A: just look at this chart.

Question #8: ''Swap spreads? Drivers at different tenors and implications for rest of markets?''

A: Swap spreads are the delta between bond yields and swap yields. They represent the credit risk embedded into the bond: buying the bond and paying the swap hedges your interest rate risk, so you're left with the credit risk only. Like the repo, they are important and neglected!

Question #9: ''Why do we still, after centuries, have politicians and the general public think that bonds need to be paid off in full?''

A: Either because they still believe the government's balance sheet works like a households' balance sheet (might well be they really believe that, still...) or because policymakers like to keep the status quo. A very well informed public opinion is always tricky to handle.

Question #10: ''Why would you hold treasury bonds in your long term portfolio when rates are zero / negative?''

A: Because rates can be even more negative / because you need something that shallows your drawdowns on risk assets / because you are forced by regulation to do so.

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