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In: Accounting

What will happen to the bond market in a recession? Kindly expand your answer, thank yo!

What will happen to the bond market in a recession? Kindly expand your answer, thank yo!

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Expert Solution

During a recession, a country’s central bank is likely to lower interest rates to make money cheaper to borrow. In the short term, this generally helps startups borrow money, and creates new jobs by, allegedly, stimulating the economy.

How do they lower interest rates? They buy bonds, which increase bond prices, including bonds you might be holding that they don’t directly buy. Therefore, during recessions, bonds should appear to do well.

“Appear?” What? Bonds actually do poorly during recessions! The reason is because the above analysis does not take into account inflation and the value of a nation’s currency on an absolute level, or even in the world market.

Consider the Early 2000s Recession in the USA. The USA FED lowered interest rates, so bonds did well, right? Only when priced in USD. In the real world, which none of the other previous 20 answers properly considered, those bonds, priced in USD, lost ~50% since then, with the USD IDX going from 120 to about 70:

The right-most grey bar shows the Early 2000s Recession. Even if you made 5%/year on the bond market, if that money is now worth ~50% less because your currency went down during the recession, you lost ~50% - (6 years x 5%/year) =30%)=~20%!

The best thing to do with your money if you think a recession is starting is to short your own currency by something like buying bonds in a country that is outperforming your own country’s currency. Unless you know for sure your country will recover better than other countries, you need to avoid being long your own country’s currency.

This is especially true when you consider how a country comes up with the money to buy bonds. It usually does so by electronically creating the money from nothing. This is inflation. Such inflation certainly lowers the value of a bond holder in real value since with bonds that purchase money is locked up; with the actual bond, the money spent cannot be taken back to short the underlying currency (without, obviously, trading it via a third party broker).

For example, if you lived in the USA, and you thought the USA yield curve was inverting, which suggests a recession is coming, you might have considered why. If you thought a reason was because the USA decided to spend trillions to hunt terrorists inside of mountains, you might have considered buying a currency of a country without much of a military, like Japan’s. Let’s see how that might have worked out:

In this case, you could have made 77% relative to USD cash without any leverage, which itself is very expensive. These days, this sort of trade is very easy to make. (You could open up an e-coin account, go long BTC/USDT, and go short an equal number of e-coins BTC/JPY.)


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