THE HINDU Editorial Vocabulary-July 12, 2017- Topic 2

 Ominous retreat

On weakening bond markets

Bond markets around the globe showed signs of weakness last week, with major central banks hinting at a possible end to years of ultra-loose monetary policy. The yield on German government bonds reached their highest level in 18 months, while that on the 10-year U.S. Treasury bonds reached its highest level in eight weeks. Results of the auction of 30-year French government bonds were the immediate trigger behind the rout as it pointed to a drop in excess demand; the bid-to-cover ratio dropped to 1.5 from 1.93 in January. 

Notably, the minutes of the European Central Bank’s June meeting indicated that the bank might walk back on its commitment to expand its €60 billion bond purchase programme. The U.S. Federal Reserve has already hiked rates this year, and warned of the risks posed by low rates. The Bank of England and the Bank of Canada have shown signs of hawkishness. Bearish comments from investors that the yield on the 10-year U.S. Treasury bonds might head towards 3% did not help matters either. The Bank of Japan has been the sole exception, promising to purchase unlimited amounts of government bonds at low rates. There is thus widespread concern among investors that central banks, through these bearish signals, may be testing the reaction of markets to a possible interest rate hike. Further, they fear the possibility of a coordinated tightening of monetary policy globally.

The fact that the drop in bond prices has coincided with hawkish central bank policy is not totally surprising. The multi-year bull market in bonds has been driven mainly by central bank purchases of government bonds; in fact, sovereign bonds yielded negative rates not too long ago. A major concern right now is whether higher rates in the bond market will spell doom for equities. After all, a higher interest rate places a greater discount on future cash flows, which in turn translates into lower equity prices. What this means for banks and other financial institutions betting on these instruments will define the systemic risk that a long-feared rate hike poses. According to estimates by Goldman Sachs last year, even a 1% increase in rates by the Federal Reserve alone would lead to losses anywhere between $1 trillion and $2.4 trillion to bondholders. This is bigger than the losses incurred during any other bond collapse in history. Even more important will be the risks to the broader economy from an end to the present regime of historically low interest rates. For almost a decade now, investment decisions have been based on low interest rates and high levels of liquidity. An increase in rates, combined with lower levels of liquidity, will require a change in business decisions and a reallocation of resources. This will mean some amount of unavoidable economic pain. In such a scenario, it will not be a total surprise if central banks decide to step back from their plans to normalise rates.

Vocabulary

Yield: give way to arguments, demands, or pressure.

Example: The Western powers now yielded when they should have resisted

Synonyms: surrender, capitulate, submit, relent, admit defeat

Treasury: the funds or revenue of a government, corporation, or institution.

Example: The country's pledge not to spend more than it has in its treasury

Synonyms: coffers, purse, finance department, bank

Auction: a public sale in which goods or property are sold to the highest bidder.

Example: The books are expected to fetch a six-figure sum at tomorrow's auction

Bearish: resembling or likened to a bear, typically in being rough, surly, or clumsy.

Example: A bearish figure with muttonchop whiskers

Widespread: found or distributed over a large area or number of people.

Example: There was widespread support for the war

Synonyms: general, extensive, universal, common, global

Doom: death, destruction, or some other terrible fate.

Example: The aircraft was sent crashing to its doom in the water

Synonyms: destruction, downfall, ruin, ruination, extinction

Incurred: become subject to something unwelcome or unpleasant as a result of one's own behavior or actions.

Example: I will pay any expenses incurred

Synonyms: bring upon oneself, expose oneself to, lay oneself open to

Liquidity: the availability of liquid assets to a market or company.

Example: We have notions of linkages between liquidity and the bond markets, and between liquidity and different assets

Scenario: a written outline of a movie, novel, or stage work giving details of the plot and individual scenes.

Example: Imagine the scenarios for four short stories

Synonyms: plot, outline, synopsis, storyline, framework, screenplay