How The Markets Would React To A Sovereign Bonds Crash

Despite the current global economic uncertainty, the global markets are continuing to remain resilient, but for how long?

What would it take to cause a financial meltdown?

How about a sovereign bond crash?

The current financial markets

The markets have remained volatile throughout the year, but overall the current markets are mostly on a high.

The NIKKEI 225 is currently +0.68% while the S&P/ASX 200 is currently at 0.33%, on the opposite end of the spectrum.

However, the SENSEX is currently -0.38% and the FTSE MIB is currently -0.29%.

There has been plenty of scaremongering and predictions of a global financial meltdown; however, the stock markets have continued to fight despite little support and a decrease in earnings.

Therefore, what would cause the financial markets to break?

Sovereign bonds

Sovereign bonds value is dependent on the countries domestic currency as well as foreign exchange.

The more unstable currency is then, the greater the risk to the bondholder.

If a country’s currency is unstable, then the government will most likely respond by denominating their bonds into the currency of a country that has a stable currency.

Currently, sovereign bonds yields are overall adamant with negative bonds currently in Japan, India, Russia, Australia, and South Korea.

The US bond yields have recently seen a decline in early July; however, they have started to show signs of an increase in recent days.

Overall, the US bonds peaked mid-2015 and had with a steep dip early 2016.

What would cause a bond crash?

Government bond rates have remained high for an exceptionally long time; this is a result of low-interest rates, risk aversion, quantitative easing, and recovery programs.

Bond yields respond to prices, so when yields increase, which will happen because of an increase in interest rates, then prices fall.

Investors will no doubt be pleased by increasing yields the potential losses from a price drop can be immense.

So, what happens if interest rates rise?

The FED last raised interest rated in December 2015, and they have remained at the current level throughout 2016.

The world has been focusing on when the US will raise interest rates again; however, what is not well known is the other counties who have cut their interest rates.

If the economy looks set to be in recovery, then Governments may consider raising interest rates.

The low-inflation, low-interest rate, low growth, low yield economy that we are currently in has created a bubble.

This bubble has increased the value of many assets.

If the bond market starts to turn because of these rises, then there is a risk of these assets falling as well.

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When will bonds crash?

The US is showing no signs of increasing their interest rates anytime shortly.

The FEDs are concerned about the US jobs market and the potential fallout from the UK referendum result.

There is a huge concern that when interest rates do start to rise that sovereign bond will crash and cause a massive economic meltdown.

This, however, will not be necessarily being the case.

It is more likely that interest rates will cause a gradual decline in the value of bond yields.

Conclusion

The current financial market is proving to be stronger than anticipated.

The financial markets have been volatile lately, and predictions of impending doom have been circulating for months.

The stock markets have mainly been remaining high with lows currently seen in the SENSEX and FTSE MIB.

Sovereign bonds affected by the value of not only domestic currency but also foreign exchange.

If a countries currency becomes unstable, then the government will respond by denominating their bonds into the currency of a more stable one.

Currently, government bonds are remaining stable, apart from a selection of countries.

US bonds have recently dipped at the beginning of the month but have recovered again.

Government bonds also tied to interest rates have been flat or cut.

The US interest rates have been low for a long time and were last raised slightly in December 2015 with little sign of an increase anytime soon.

The current economic climate has created a bubble in which bonds have increased the value of other assets.

If interest rates were to rise then, this would cause bond yields to fall, which in turn would cause other assets to fall along with it.

There has been plenty of speculation surround when sovereign bonds will fall.

However, it is impossible to know when this will happen exactly.

The US is showing no signs of increasing their interest rates until at least 2017.

There is also the likelihood that the effect of interest rate hikes will be gradual and not as dramatic as first feared.