The major risk to the global bond bubble

In the span of two years, the global government bond market grew from $10 trillion to $50 trillion in size.

Interest rates are projected to rise as central banks take a step back and economies continue to recover.

“Price-insensitive” investors’ role in lowering yields is at least bolstered by the weight of all that debt.

In addition to the demand from pension funds and insurance companies, which remember the U.S. defined-benefit funds that converted to bonds, their existence helps to explain the waves of purchases that have contributed to capping 10-year Treasury yields at around 1.7% this year.

After the bankruptcy of Lehman Brothers, banks were required to hold sovereign securities as a condition of doing business.

Additionally, central banks possess trillions of dollars in QE programs as well as in their foreign-exchange reserves.

There is some comfort in the fact that long-term investors are confident that interest rates will continue to remain low, but they also highlight the hazards of rising interest rates, which will reduce liquidity and increase the risk of excessive volatility.

There is less free float in global bonds since central banks may already own half of the markets.

For Germany’s government bonds, Deutsche Bank estimates that the free float is less than 10%.

For QE stakes, central banks may be able to weather the storm, but currency reserves are another else entirely.

In the event that a bank has a big amount of what is intended to be a high-quality, liquid asset and it turns out to be illiquid, what will happen to the bank?

Because of the rise in outstanding bonds and the resulting lengthening of the maturity period, higher yields have the potential to cause even more harm.

Central banks will have a very low bar to clear to intervene in the market if interest rates begin to rise.

In the US, hikes are now priced for March, June and Dec. 3rd hike in Nov (47%) and a 4th hike in Feb 23 (40%) are close.

According to the table, four rate hikes are anticipated over the next 14 months.

The market is pricing in a terminal funds rate of around 1.75%, which would indicate that rate hikes have reached an unsustainable level.

Here is a reminder of the events that occurred when the Fed’s rate hiking went too far.