Trinity's Take: What's with all these bonds??

[TrinityeXchange]

Peter Eerdmans is an economic prophet, “As interest in emerging market debt grows, bond markets are developing in size, depth and liquidity. Some countries such as Lebanon, Iraq, Tunisia, Panama and Guatemala only issue dollar government bonds but Mr Eerdmans expect this to change in the next decade to include issues in local currencies.”  (read more: Interest in local currency bonds rise)      

 

Hello again my friends!  There is so much talk in the news surrounding bond issuance that I thought I would take an opportunity to elaborate and give my short take on what it is I believe the GOI is doing.  But first a quick educational session so that we are all up to speed.  A government will be the issuer of a bond when it is looking to borrow money.  The GOI sells the instrument and redeems it at a later date in time at a predetermined or fixed rate.  At the end of the term (maturity) the investor cashes in the bond for the fixed amount.  This is why monies received from bonds are called “fixed income” to the investor. 

 

For our purposes we will discuss EMLCB or Emerging Market Local Currency Bonds.  What we see transpiring in Iraq is for all intents and purposes unprecedented because it is for the first time issuing EMLCB or another common phrase “emerging local market bonds.”  Previously Iraq only issued bonds denominated in foreign currency (usd).  Now we see them issuing bonds denominated in the iqd.  Within the last couple of weeks we see both types of bonds being made available to add liquidity to the economy.  The question many probably have is why LCBs?

 

Issuing a bond in foreign denominations is a no-brainer as the investor is assured of the stability of the currency in which the bond is denominated….for Iraq it is the usd.  Purchasing bonds in local/domestic currency serves a 2 dimensional purpose, 1) the hopes of receiving a fixed income upon bond maturity (same as foreign denominated bonds) and 2) the hopes of receiving capital gains if the domestic currency appreciates in value J  Point #2 is the ONLY reason a foreign investor will purchase an EMLCB when they have the option of purchasing a less riskier foreign currency denominated one.     

 

Lastly, so that people don't think I am pulling my takes out of a hat, these bullet point items were taken from Investec's report "Emerging Markets Debt: the next 10 years":

• Borrowers would rather repay debt and interest in the same currency as their income.  As international lenders gain more trust in the credibility of monetary and fiscal policies, they become increasingly willing to lend in local currencies
• Local currency bond issuance to dominate in an increasing number of emerging markets
• Economic growth, macro and political stability and market liquidity attract international investor interest as new markets present opportunities for diversification and potentially higher returns;
• We see the current trend of increasing foreign participation in emerging bond markets continuing at a steady pace – although not quite reaching developed market levels over the next ten years.  

I tried keeping it as short as possible while covering pertinent points.  Thanks for reading, your mileage may vary  .  

 

Be blessed my friends!

[umbertino]

Grazie for sharing

[boosterbglee]

Thanks Trinity! 

[fancy]

Thanks Trinity! I've learned so much from the information you bring to us. Lots going on in Iraq and I have a better understanding through what you bring! Thanks so much,I very much appreciate you! We ride this to the end!

[Wiljor]

Thanks TrinityeXchange, again your imput brings light to the matters that be and is very much appreciated. We have a clear intent in what Abadi and crew wish to accomplish and now we see many moving pieces of this chess game hopefully getting us closer to the infamous check mate.

Much abliged, as we patiently wait....

[Laid Back]

Thanks for your input TX.

Iraq is moving fast in the right direction.

[sandfly]

THANKS

[calkid11]

Thank you

[sourpuss]

Thank you for sharing your insight.

[EverCurious452]

1) the hopes of receiving a fixed income upon bond maturity (same as foreign denominated bonds) and 2) the hopes of receiving capital gains if the domestic currency appreciates in value J  Point #2 is the ONLY reason a foreign investor will purchase an EMLCB when they have the option of purchasing a less riskier foreign currency denominated one.     

Hi Trinity,

  Point #2 is certainly a possible reason to buy such a bond, but I suspect the more dominant one is just higher interest rates.  The riskier the bond the higher the rate must be to attract buyers.  e.g. junk bonds where there is a clear risk of not paying off, pay a really high rate and can be quite speculative. I think EMLCB's are very unlikely to be in the junk category but by their "emerging nature" so to speak, I think generally will have more risk and so will have to pay higher rates.

[TrinityeXchange]

Hi Trinity,

  Point #2 is certainly a possible reason to buy such a bond, but I suspect the more dominant one is just higher interest rates.  The riskier the bond the higher the rate must be to attract buyers.  e.g. junk bonds where there is a clear risk of not paying off, pay a really high rate and can be quite speculative. I think EMLCB's are very unlikely to be in the junk category but by their "emerging nature" so to speak, I think generally will have more risk and so will have to pay higher rates.

i appreciate your feedback and agree with you that investors both foreign and domestic are enticed to purchase bonds from developing countries by their favorable interest rates.  where i disagree is the interest rate being the difference between a dollarized emerging market bond and a localized currency emerging market bond.  the only difference between the two is the additional gains foreign investors might realize from an appreciation of the local currency on an EMLCB.  

 

=====================================

this article does a great job explaining it. 

 

The second type of emerging debt is bonds that are denominated in local currencies rather than U.S. dollars. In this case, the investor will have to convert their dollars to, for example, the Brazilian real prior to buying the bond. The result is that he or she will now see the value of the investment affected by currency fluctuations in addition to the price movement of the underlying bond.

 

Why is this? Think of it this way: an investor buys $1 million worth of Brazil’s local currency debt, but to do so they first need to convert their dollars into the local currency. A year later, the price of the bond is exactly the same, but the currency has appreciated 5% versus the dollar. When the investor sells the bond and converts back to U.S. dollars, that 5% appreciation leads to a 5% gain in the value of the investment – even though the price of the bond itself was unchanged. ( read more)

Edited August 30, 2015 by TrinityeXchange

[MyLadiesDaddy]

  Point #2 is the ONLY reason a foreign investor will purchase an EMLCB when they have the option of purchasing a less riskier foreign currency denominated one.      

Read more: http://dinarvets.com/forums/index.php?/topic/207394-trinitys-take-whats-with-all-these-bonds/#ixzz3kGBiKFer

 

So let me get this strait Prof. T, 

 

It seems to me, a simple truck driver, that what your describing is essentially the same as 

 

what we've done by purchasing the actual currency. Minus the interest earned by the bond. 

 

I personally find that to be very telling of future projections as much as world emerging markets

 

are concerned. And what with the IMF talking so much about emerging markets and a

 

basket of reserves currencies, one can only wonder that the IMF is looking to what there referring to  

 

as, Emerging Markets, as the way out of the current crisis. 

[TrinityeXchange]

  Point #2 is the ONLY reason a foreign investor will purchase an EMLCB when they have the option of purchasing a less riskier foreign currency denominated one.      

Read more: http://dinarvets.com/forums/index.php?/topic/207394-trinitys-take-whats-with-all-these-bonds/#ixzz3kGBiKFer

 

So let me get this strait Prof. T, 

 

It seems to me, a simple truck driver, that what your describing is essentially the same as 

 

what we've done by purchasing the actual currency. Minus the interest earned by the bond. 

 

I personally find that to be very telling of future projections as much as world emerging markets

 

are concerned. And what with the IMF talking so much about emerging markets and a

 

basket of reserves currencies, one can only wonder that the IMF is looking to what there referring to  

 

as, Emerging Markets, as the way out of the current crisis. 

my friend you have said a mouthful in that one paragraph.  firstly, yes and exactly, the reason you purchased dinar is the same reason a foreign investor would purchase a local currency bond because of the calculated risk potential for the local currency to appreciate in value.  however, there is no guarantee....it is indeed risky but as long as there is a market for it, the goi is foolish not to make the LCB available.  and note that iraq is offering LCBs for the first time ever in its country's history.  of course some guru would run away with this information as an impending rv guaranteed to happen  but we more level headed speculators probably don't see it that way.  instead we read this taking place and note it as "interesting" 

and again, you are spot on.  christine lagarde, managing director of the imf, has expressly stated the vital role emerging economies MUST play in rebalancing the global economy.  her recent concerns are that emerging markets are becoming too complacent.  in essence she is promoting them to ramp up their efforts to produce a robustly growing economy.  the rest of the word NEED the middle east and north africa to open up their economies to foreign investment.  

 

==============================

 

The head of the International Monetary Fund is warning leaders of emerging-market nations to avoid complacency in the face of what could be a sustained economic slowdown. “Six months ago, I warned about the risk of a ‘new mediocre’ -- low growth for a long time,” IMF Managing Director Christine Lagarde said in a speech Thursday at the Atlantic Council.

 

“Today we must prevent that new mediocre from becoming the ‘new reality,'" Lagarde said. "The bottom line is that risks to global financial stability are rising. The ‘new mediocre’ growth environment is not a comfortable place with respect to financial stability."

 

(read more)

Edited August 30, 2015 by TrinityeXchange

[MyLadiesDaddy]

The head of the International Monetary Fund is warning leaders of emerging-market nations to avoid complacency in the face of what could be a sustained economic slowdown. “Six months ago, I warned about the risk of a ‘new mediocre’ -- low growth for a long time,” IMF Managing Director Christine Lagarde said in a speech Thursday at the Atlantic Council.

 

“Today we must prevent that new mediocre from becoming the ‘new reality,'" Lagarde said. "The bottom line is that risks to global financial stability are rising. The ‘new mediocre’ growth environment is not a comfortable place with respect to financial stability."

 

Read more: http://dinarvets.com/forums/index.php?/topic/207394-trinitys-take-whats-with-all-these-bonds/#ixzz3kGX1IGnV

 

That's a very powerful statement coming from the Director of the IMF. 

 

Comments like that can create serious ramifications and unintended consequences. 

 

Being the consummate conspiracy theorist I've had difficulty in deciding if everything 

 

about dinar and worldwide financial events is completely planed and controlled.  In the end

 

I've settled on the belief that everything is under total control, just not by man. Therefore, 

 

giving the allusion of some grand scheme beyond anyone's understanding. When in fact 

 

it's the, "powers and principalities", that are really running the show. That being said I 

 

find Ms. Lagarde's comments dangerous at best. They may also account for China and 

 

other smaller nations actions of late, ie. devaluation of the Chinese currency and the 

 

depegging  of others from the dollar. 
 

IMO I think that these recent events have started what will appear to some as a worldwide 

 

reset, when in actuality will most likely only be everyone out for themselves. 

 

In the end, if the Bible is to be believed, the IMF will step in and create a non-currency one

 

world purchasing system claiming that without such a system the entire financial house of 

 

cards will come tumbling down. You and I both know how many people will gladly receive it.     

[TrinityeXchange]

i feel you brother.  whether there is a conspiracy at play by men or unwittingly being lead into the devil's net, at the end of the day the outcome will be the same because the entire system is financed upon a lie.  the devil's unsustainable system of greed fed by eternal debt through a nonsensical fiat machine will inevitably leave the world destitute.  world powers are frantically searching for new sources to feed the gigantic debt monster and MENA (middle east north africa) is the target.  their efforts to sustain this global debt disaster is sincere; though salvation is futile.  for a short time, MENA might fill the need and stave off global collapse for a moment.  eventually though the competitive fight for global resources will drive mankind to what we understand is already foretold in the Holy Bible.  thank God i am on The Lord's side.

 

if only men held value in God's way and was not lead by greed and debt (slavery), they might be saved.  consider the wonder in the Almighty's wisdom when He instituted The Year of Jubilee.  the 50th year!  the year following seven sabbatical years.  a year that all men would experience at least once in their lifetime where all debts were forgiven and all land returned to the original owner.  a year where servants were released to pursue their own dreams.  how fantastic are His ways.  imagine the healing and hope such a year must bring.  

 

the world however would never hear or consider such a thing because greed and debt is their god.

[EverCurious452]

i appreciate your feedback and agree with you that investors both foreign and domestic are enticed to purchase bonds from developing countries by their favorable interest rates.  where i disagree is the interest rate being the difference between a dollarized emerging market bond and a localized currency emerging market bond.  the only difference between the two is the additional gains foreign investors might realize from an appreciation of the local currency on an EMLCB.  

All else being equal, sure.  But would it be?  If the perception is a risk of depreciation the rate might have to be higher for local currency bonds then USD bonds.  Also of course if the rate goes up the country has to pay off in more valuable currency so wouldn't issuing local currency bonds be an incentive (not a determining one but pressure in this direction) to not raise the exchange rate?

[TrinityeXchange]

All else being equal, sure.  But would it be?  If the perception is a risk of depreciation the rate might have to be higher for local currency bonds then USD bonds.  

i believe you might be right in your assumption EverCurious452.  revisiting one of the articles on the subject states the following:

"Mr Eerdmans expects a 7-8 per cent return from local currency bond funds, compared with 5-6 per cent on their hard currency counterparts over the next 12 months. The difference is due to a slightly higher yield on local currency bonds and expected currency appreciation. "

 

Also of course if the rate goes up the country has to pay off in more valuable currency so wouldn't issuing local currency bonds be an incentive (not a determining one but pressure in this direction) to not raise the exchange rate?

i disagree that preventing the currency to appreciate in value will keep the country from a more expensive payoff.  firstly, the country's currency, for all intents and purposes, is not any more or less valuable for domestic purposes.  the value of domestic currency really comes into importance when compared to international markets, wouldn't you agree?  the concept of an exchange rate is only relevant for international commercial intercourse.  secondly, a developing country would actually prefer to borrow in its domestic currency as opposed to dollarized borrowing because of the risks of a stronger dollar and weakened domestic currency.  

Edited August 30, 2015 by TrinityeXchange

[EverCurious452]

i disagree that preventing the currency to appreciate in value will keep the country from a more expensive payoff.  firstly, the country's currency, for all intents and purposes, is not any more or less valuable for domestic purposes.  the value of domestic currency really comes into importance when compared to international markets, wouldn't you agree?

For small appreciations I do agree, though the appreciation factor was an advantage for "foreign investors" not local investors so there paying off in an appreciated currency, which will be immediately exchanged back into dollars or euros etc will make the payoff more expensive.   i.e. if its an advantage for the buyer it has to be a disadvantage for the seller.

[TrinityeXchange]

For small appreciations I do agree, though the appreciation factor was an advantage for "foreign investors" not local investors so there paying off in an appreciated currency, which will be immediately exchanged back into dollars or euros etc will make the payoff more expensive.   i.e. if its an advantage for the buyer it has to be a disadvantage for the seller.

EC, if you want to read more on the subject, i encourage you to review this article.  i posted an excerpt below.  the imf also posted a thorough writeup of LCBMS.  developing countries prefer to borrow in their own domestic currency (view expressed by economic experts). to me it makes complete sense.  somehow it appears that you are implying the borrowing country also pays all of the exchange transaction fees, and so it is making it difficult to understand your logic.  

 

when i purchase stocks on the isx, i first wire from my bank, through intermediary banks and finally into iraq where my funds in usd is converted into dinar.  the dinar is then transferred into the trade bank of iraq into an account that my broker has access to transact the buy and sell of stocks.  on my receipt it is evident that i paid all of those fees not iraq.  when i sell the stock and wire the money back to the states, i incur all of those fees, not iraq.  iraq could care less what currency i converted MY DINAR into.  it is completely neutral to them.  if the dinar appreciated or depreciated in value, iraq could care less.  

 

the only time iraq should care about exchange rates is when it borrows in a foreign currency because iraq must exchange the currency for domestic use and iraq foots the bill this time for the exchange fees.  when it comes time to pay the creditor back, iraq must exchange the dinar back into the original currency form and this is where they might take a hit if the original currency appreciated in value.  

 

=========================

 

Drivers of return: local currency emerging markets bonds

 

Improving creditworthiness is a less prominent contributor to

returns in the local bond market. Currency appreciation, a

gradual downward move in domestic interest rates and,

increasingly, shifts in the shape of the yield curve are the key

drivers of return.

 

As the chart below shows, currency appreciation has historically

made a significant contribution to local bond returns. While

currencies can be volatile, the transition to floating exchange rate 

 

 

regimes by many developing countries and the steady

accumulation of foreign exchange reserves by their central banks

has given investors a greater degree of comfort with currency risk

in emerging markets. There are many reasons why currency

appreciation can potentially continue to be a key source of return.

Emerging markets’ rising productivity and growth relative to the

developed world, their improved terms of trade and exposure to

rising global commodities can be expected to serve as a magnet

for investment inflows over the medium term and longer.

Currency aside, local currency bonds also allow investors to

better capitalize on one of the key benign forces shaping

developing economies. Domestic inflationary pressures once

these countries’ Achilles heel — have been steadily reduced.

With many nations both better equipped and more willing to bear

down on inflation than at any point in their history, be it through

monetary policy, deregulation or labor market reform, there is

plenty of scope for both real and nominal bond yields to fall and

converge with yields in developed bond markets.

 

In contrast to dollar bond markets, local yield curves of emerging

markets sovereigns also tend to be quite varied, since countries

are often at different stages of monetary and fiscal cycles at any

given time. This allows investors to evaluate relative value along

the yield curve in individual markets as well as value across

various markets. As governments seek to extend their yield

curves, the range of investment opportunities will broaden.

 

Because local currency bonds are closely tied to their countries’

fiscal, monetary and macroeconomic policies, they can offer an

attractive risk-reward trade-off for investors seeking currency

diversification. And as sovereign borrowers build their local

currency bond yield curves, duration and curve positioning will

also become increasingly important sources of return. 

[EverCurious452]

 somehow it appears that you are implying the borrowing country also pays all of the exchange transaction fees.

I wasn't thinking of transactions fees at all, just the appreciation.  If I exchange USD for IQD, then sometime later (whether I have invested them in a stock, or a bond or just held them) if IQD has gone up and I exchange them back, the CBI pays our more so I make money and the CBI loses the same amount (just considering those two transactions).  Now in the case at hand we're talking about small increases and the bonds being a small percentage of the Iraqi money supply so upon reflection I can't see bond sales being a factor at all in their thinking about the exchange rate.  (so never mind! :-)