Central Bank Intervention

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1 Central Bank Intervention Arjun Parthasarathy Founder INRBONDS.com 1

2 Agenda Why do Central Banks Intervene in Financial Markets? Impact of Intervention on Yield Curves, Liquidity Effect of Central Banks Intervention on Fixed Income Funds 2

3 Why do Central Banks Intervene in Financial Markets 3

4 Central Bank Intervention is Short Term Price Manipulation of Currencies and Securities that is not Sustainable over a Longer Period of Time 4

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7 Black Wednesday -16 th September 1992 Bank of England lost GBP 3.4 billion on intervention George Soros made GBP 1 billion on selling GBP GBP was forced out of the European Exchange Rate Mechanism (ERM) 7

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11 April-June 2015 High Volatility in US Treasuries, German Bunds US ten year treasury yields rose 60bps from lows German Bund Ten year yields rose 90bps from lows Worries of extreme low levels of yields on QE UST, Bunds no longer risk free 11

12 Asian Financial Crisis Asian Central Banks intervene to prevent sharp currency depreciation Severe depletion of foreign exchange reserves IMF aid (South Korea, Thailand), Capital Controls (Malaysia) 12

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14 RBI July 2013 RBI selective intervention on sharply depreciating INR Fed Taper Tantrums forcing FIIs to sell INR Bonds RBI squeezes liquidity, raises interest rates 14

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16 Swiss National Bank (SNB) Buys unlimited Euro to maintain Swiss Franc (CHF) at Eur 1.20 levels, from 2012 SNB scraps the peg in January 2015 and cuts discount rate to -0.75% CHF gains 30% in one day leading to huge losses for traders 16

17 Why do Central Banks Intervene? Central Bank interventions fail to achieve its original purpose Intervention comes at a huge cost, borne by the tax payer Yet Central Banks intervene and will continue to intervene 17

18 Cost of Intervention Outright cost Losses Cost of Stability Depletion in fx reserves Indirect cost Inflation, distortion of prices, asset bubbles 18

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23 Impact of Intervention on Yield Curves, Liquidity 23

24 Intervention Distorts Prices Currency values are artificially set in short term Yield curves are twisted out of shape Asset price bubbles formed 24

25 Fed Operation Twist Flatten the yield curve Sell short, buy long USD 667 billion in 2011 Has on knock on effect on mortgage rates 25

26 Liquidity Impact of Intervention Sharp fall / rise in liquidity impacts interest rates and asset prices Liquidity management gains importance over other policy objectives Long lasting impact on markets 26

27 Impact of Intervention on Fixed Income Funds 27

28 Impact on the Short End Intervention affects liquidity and yields at the short end of the yield curve Funds at the short end of the yield curve is highly impacted by intervention AUMs and returns turn volatile on intervention 28

29 Influence on Long End not well established Intervention does affect the long end of the yield curve in the short term, but longer term relationship is not clear AUM s and returns of long bond funds are affected in short term In the long term, outlook on growth and inflation impacts long bond funds 29

30 Intervention Impact on Credit Spreads High impact on credit spreads Credit based funds impact on AUM and Returns extremely high Artificial pricing of credit 30

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34 Thank You Information herein is believed to be reliable but Arjun Parthasarathy Editor: INRBONDS.com and Zephyr Financial Publishers Private Limited does not warrant its completeness or accuracy. Opinions and estimates are subject to change without notice. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The financial markets are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved. Unauthorized copying, distribution or sale of this publication is strictly prohibited. The author(s) of the content published in the site INRBONDS.com may or may not have investments in the assets discussed in the pages/posts. Copyright INRBONDS.com by Arjun Parthasarathy