Dear Steemit-Community,

I have just picked up a copy of Steve Forbes book - Money: How the Destruction of the Dollar Threatens the Global Economy – and What We Can Do About It .

Steve Forbes is an advocate of a gold standard, which would be in my opinion the wrong solution. But that should not be today's topic.

On page 10 I found the following quote:

So according to Steve Forbes, the Fed announced that they would taper the QE program, which made yields on the 10 year treasury note spike up to 3%. Therefore lot's of money was flowing into the US government bond market, which produced a sell off in certain emerging market currencies.

Well, this is what a lot of economists (who do not trade) think, but this is not how it works.
First of all, I have already shown, that the Fed has zero influence on interest rates here and here.

But now let's have a look how bond prices and interest rates work.
Before we look at a chart, please keep the following quote in mind:

Bond prices and interest rates are negatively correlated.

When bond prices go down, interest rates go up; When bond prices go up, interest rates go down.

Here you can see the inverse relationship between bond prices and interest rates:
1. 10 year Treasury Note Price:

image source: thinkorswim trading platform


2. 10 year Treasury Note Yield:

image source: thinkorswim trading platform

So there is a reason why the yield on the 10 year treasury note rose from 1.6% to 3%, but the reason was not the Fed.

The reason was that investors sold treasuries on a large scale and buyers only accepted them at lower prices (with a higher yield).

So money was flowing out of the US government bond market and not into the US government bond market.

Now the question remains, why the currencies of the emerging markets sold off against the US dollar.

First of all, in financial markets nobody knows anything. There are numerous reasons why the price of an underlying equity or bond rises or falls.

The only people responsible for changing prices are the buyers and sellers.
When buyers are willing to buy at higher prices and sellers are willing to sell at those higher prices the underlying equities rise and when buyers are only willing to buy at much lower prices, then prices fall.

But let's try and find a reason for the sell off in emerging market currencies anyway.

Most of the debt of these emerging market countries is denominated in US dollar, since there is not enough credit available in those countries and because international lenders are reluctant to invest in a debt instrument denominated in a currency which is very volatile and is usually a subject to high inflation. If they do, they demand a very high yield as a premium for this extra foreign exchange and inflation risk.

But it is not only the government of an emerging market country which has debts denominated in US dollar, but it is also businesses in those countries, which have huge debts denominated in US dollar.
Usually this loans have variable yields.

When now the interest rates in the US go up, these companies have a problem. At a certain rate they can no longer afford to pay the interest on their loans, so they sell off assets in order to pay back these loans.
Since these loans are denominated in US dollar, they have to exchange their own currency for US dollars.
So the demand for US dollars rises and the demand for emerging market currencies falls.

That is what made the US dollar rise against the emerging market currencies and not the attractive bond yields.

I hope everyone understands now, that the money did not flow into the US bond market, since interest rates were so attractive, but that money was "forced" from the emerging markets into the US to pay back loans.

Have a great weekend,
Stephan Haller