July Inflation | Page 4 | General financial discussion | Discussion forum

Vatox said

Interest on government bonds is not a function of yield my friend. The government pays a set coupon rate from issue date to maturity. Yields and prices change in trading of bonds. The government does not pay less interest just because yields decrease!  

The government pays a set coupon rate. Which is interest. So the government pays interest. Yields do change. But they are a function of the fixed coupon. The reason yields change is because they are also a function of the price. Which is impacted by government buying bonds. Which in turn impacts interest on new issues. Nu?

You seem to think that government bonds are issued by governments in outer space and that governments have complete freedom in setting the interest rate on their bonds. Not so. In the real world these rates are driven by the market for debt from the government. Governments have influence. And they can try to manipulate the market. And they will succeed. Up to a point.

Yep.

Lets try another way - and be done with it because we are moving away from the topic.

Oil prices are falling. At below $30 a barrel, the industry is going to suffer. After successful lobbying, US government buys lots of oil. This supports the price of oil. For a while.

Now bonds. Government tries to sell 10 year bonds with a 2% coupon. It set a low interest rate for overnight loans. Expected annual inflation over 10 years hits 3%. Potential buyers say “no thank you. You are asking us to take an annual loss of 1% for 10 years. Put your bonds where the sun dont shine”. The government is running a deficit, so its forced to up the coupon so reasonable buyers of debt would bite.

Another option is for a government organization to jump into the breech and buy all that debt that nobody wants. That supports bond prices, lowers the interest and messes with the market. Now buyers say “we cant lose because the government will support and raise the value of bonds”.

Same as with oil prices.

People who hold bonds like it when the government buys more and more bonds because it makes their bonds more valuable. Thats the only reason to buy these bonds today. Conversely bond investors dislike when the government (eventually) sells all that paper. Every time the government tries to unload them, there is a scare in the market. Thats how you create a bond bubble.

Vatox said
I guess what I am saying is, I don’t see falling yields leading to lower future issued coupon rates. And therefore I don’t see any gain for government on the rate side. So the “manipulation” is to remove debt only. I suppose you can say the manipulation is to reduce yield for trading, but that is not a concern for government and they wouldn’t bother doing it for that, it’s just a side effect of removing the debt from the market. Traders may not like the falling yields, but the government doesn’t gain from that. And perhaps that’s what you may be getting at, the government is manipulating the yields and it is affecting traders.  

A new bond will be issued at par, which means the coupon = yield at the get go. If a current similar bond is trading at 2%, the new one will be priced at a yield/coupon at similar level. So govt by ‘influencing’ yield of currently traded bonds, it directly ‘set’ the borrowing cost for the new issues coming up.

Even if credit quality deteriorates, the yield on the current bond will already reflect that broadly speaking. So the new bond will be issued at similar yield, again coupon = yield initially. Of course if demand just dissipates, then theoretically the coupon has to go up to attract investors. But with central bank acting as a buyer if needed, it puts a ceiling on the coupon needed. At the end of the day, it is creating money out of thin air, but all of G7 doing it.

Vatox said
I’m under the impression that new coupon rates are based on the central bank rate and not the current yields. This is because the initial buyers are generally banks themselves. The banks can utilize the central bank rate and won’t purchase a bond at face value with a coupon rate far below the central bank rate which is where the yields may currently be.

In fact I would even suggest that QE would more likely increase new coupon rates because the increased money supply by QE generally(not always) leads to more economic activity and inflation and that inflation leads to higher interest rates not lower. It doesn’t always come out that way but I do not see lower coupon rates on newly issued bonds because yields have gone down. The yield isn’t an interest rate anyways, it’s simply the calculated return. I am not seeing why everyone thinks yields are interest, they aren’t. That’s like saying your bank account savings rate will decrease because bond yields are decreasing, not true.

EDIT: in other words, the initial buyers won’t accept lower rates because that initial yield being equal is too low and they will bid the price down at auction. The government wants their bonds sold at face value and will ensure that happens with a competitive coupon rate.  

Central bank sets the overnite rate called the bank rate (just to simplify for ease of understanding). Bank’s prime rate is set as a spread over the cb’s rate. CB rate is essentially what the big6 can lend or borrow from the CB for cash management. Prime rate is what bank charges it’s ‘prime’ customers so to speak.

Bond yield is based on whatever mkt is trading based on maturity of the bonds, that is called term structure of interest rate, or a yield curve. It’s not set by the CB and it’s also not just one rate either.
Treasury dept of the govt issues bonds, CB does not.