The Asian Bond Bubble

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There is a strong sentiment being felt in the market right now which says that as credit markets in the West see an outflow of funds due to deepening eurozone crisis and a floor on the interest rates, more and more funds are being directed to the Asian bond markets. Many of the scalpers feel that the interest rates seem better in the Asian markets and there is a capital gain to be made in light of interest rate cuts that are taking place in markets of China, Australia and Hong Kong. Bond prices depend mainly on the interest rates prevailing in the market and the risk associated with it.

The interest rates are set by the Central Bank while the risk is more dependent on the seller of the bond. Ever since the global financial crisis struck the US and European markets, the interest rates in Europe and America were cut down to 0.5% and have been steady since then. This means that if there was any price appreciation expected from any further rate cuts, it has been eliminated. On the other hand, the credit risk of the borrowers has remained steady meaning that bonds from sovereign ones to company-based ones have hit a stagnated return. With the exception of the sovereign debt of debt-ridden countries like Greece, Spain and Italy, there has actually been a fall in returns from bonds.

The case for Asia has been drastically different. The economic resilience of the emerging markets was better in Asia and due to that, the effect of the recession was delayed and slow. It is only now that Chinese and Indian manufacturing are seeing a fall for the first time since the crisis and they are on a downward trend. This means that in order to stimulate the economies, the respective central banks will take the necessary steps. This would include the corrective fiscal and monetary measures and as slowdown ripples through out, interest rates would be expected to fall.

This would lead to a widespread rise in debt markets of Asia as a whole. Due to this, Goldman Sachs recently predicted that Asia will see a bond market bubble. This effect can be magnified once the credit risk of the bond also rises in Asia. This would happen if the bonds have risky debts on their books that are expected to default. These would include the European debt which would lead to a rise in the price and return yield given by the bonds themselves leading to an even greater price increase. The call by Goldman seems to be coming true as more dismal economic results are being seen day by day.

This could also mean that money moves from the Western markets to Eastern ones. In addition to that, it will move towards safer investments like commodities and bonds. The situation is conditional on the eurozone crisis and the US fiscal cliff and as the deadline approaches on both, the outlook seems to be erring on the side of pessimism at this point.

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