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Financial Market Essay

2665 words - 11 pages

hName of Student: Marc- Edouard KolloName of Professor: M. BoukraniCourse Details: Fianancial marketDate of Submission: 28th November 2014Financial markets/ Bond prices and Treasury financingThe issuance of new (government) bonds to finance the U deficit.Treasury securities have increasingly attracted strong global demand, enabling the US government to finance large deficits with ease even as critics view the issuance of new Treasury bonds negatively (Congressional budget office n.p). The US Treasury has increasingly issue new bonds to aid in financing the bailouts from the financial crisis of 2008 as well as the rising budget deficits resulting from increased government spending. The increased spending was meant to stimulate the economy at a time when the tax revenues were undergoing slow recovery from the recession. The government's cut in public spending has seen these budget deficits rapidly decline as tax revenues from the rising economy rise. The federal budget deficit is expected to narrow down to approximately $514 in the 2014 fiscal year as compared to $1,4trillion in 2009, and the Treasury may be inclined to issue a significant amount of bonds to finance the operations of the government (Congressional budget office n.p). If the Fed fails to taper back the rate of bond buying as fast as the Treasury issues new bonds, the Fed will be inclined to purchase an increased number of Treasury bond sales even if it tapers back on bond buying.The degree to which low bond yields that have higher bond prices are created from the Fed's bond buying will not likely have an impact on the gradual taper plans of the Fed (Congressional budget office n.p). Bonds rally with weak economies and the slowing economic growth in the US is no exception. The spike in bond prices during the 2008 recession and the bond rallies three summers after the economic recovery is evidence of this. During the financial crisis of 2008, short term nominal interest rates were lowered to zero as the Federal Reserve expanded its portfolio of long-term securities to spur economic growth, avoid inflation and reduce unemployment rates. The resultant purchase of long-term securities was controversial, partly because of the interest rate risk it attracted including the likelihood of an increase in interest rates. 2. The expected upward pressure on interest rates due to Treasury financingIn 2013, interest rates on 10-year Treasury bonds increased by a full percentage point from 1.72 percent to 2.72 percent indicating a 10% loss in bond prices (Levit, et al. 4). The rise in long-term interest rates initiated an increase that will propel investors towards seeking extra yields by placing bets on long-term bonds. Over the past years, long-term bonds have attracted an abnormally low interest rate due to the unconventional monetary policy that has resulted in the Fed purchasing large amounts of Treasury bonds as well as other long-term assets also termed...

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