Central bank money stimulation and bond prices

CFA Level III
#1

How is increased money supply not good news for bond holders? Increase money supply -> downward pressure on interest rates -> higher bond prices? What am I not understanding here?

From Reading 16 EOC:

Central Bank Money Supply : A 15 percent increase in money supply represents central bank monetary stimulation. Such stimulation should foster stronger economic growth (positive equity impact). However, bond yields could be expected to increase because monetary stimulation may increase expectations for higher aggregate growth and because of the potential higher inflation that monetary stimulation can cause over time (negative corporate bond impact).

#2

Exactly as it says… they’re playing the reverse game lol…

When lots of people buy puts, thats a bearish signal… however, when there’s a massive amount of puts, its a bullish signure.

When you have a massive amount of short shorting a stock, that becomes a bullish signal.

If inventory to sales ratio declines, then thats a signal that future quarters will have explosive growth! lol.

The investment game likes to flip flip a lot.

#3

So are you saying that that if the increase in money supply were less, say 1% instead of 15%, my conclusion would be correct. But the fact that the money supply is increased at such a massive scale changes the outcome?

#4

how are you connecting increasing money supply to lower interest rates?

increasing money supply puts pressure on inflation.

#5

All else being equal, larger money supply lowers interest rates. That’s basic monetary policy.

#6

what eoc problem are you referring

#7

They money supply thing is from L1. Cod is correct, basic monetary policy is to flood the market with $$$ to lower interest rates.

I think thats called Open Market something…

#8

Cod–another way to look at it is:

increased money supply = low interest rates = cheaper cost of capital = investors seeking higher returns (i.e. equities > bonds)

#9

reading 16 EOC 16

#10

The question to answer is: If each scenario occurred, would risk premium increase or decrease?

With expansive monetary policy, banks lend to corporations at lower interest rate => corporations can lower interest rate for new bonds => risk premium for existing corporate bonds (issued 1y ago) increases, since chance of defaulting on payment or calling previously issued bond increases.

#11

I have the same initial question as Codtrawler and none of these explanations is making much sense to me either. Does anyone else have a better explanation?

Also, 125mph, the following comments

-When lots of people buy puts, thats a bearish signal… however, when there’s a massive amount of puts, its a bullish signure.

-When you have a massive amount of short shorting a stock, that becomes a bullish signal.

are incorrect. I’m hesitant to correct anyone on here since I’m a level 3 candidate as well, but I’ve been an equity options trader for 12 years and I can assure you that those statements are not true

#12

I also don’t understand this point. I would say the same as cod: increase in MS --> decrease in rates --> good for bonds

I understand also, looking from the other point of view, that this could stimulate the economy, leading to some inflation and so equity are better (higher return and better inflation hedge).

It’s kind of a subjective thing, isn’t it?

It’s the same if you look at question 9D of the 2016 essay mock. Inflation below expectation: it’s good for bonds. But from the CFA book, we know exactly the opposite: inflation at or below expectation neutral for bond.

So were is the truth (if there is one) ?

#13

My reasoning, however, it may not be correct:

Bad for bonds

  1. Increase money supply will potentially boost inflation upwards, which will have a negative impact on bonds.

  2. Increase money supply will decrease near term interest, which may be beneficial for some bonds with shorter duration. But they (Central Banks) don’t control the long-term interest rates. I am not saying that it wont change, but it may not.

Good for equity

  1. Potentially more loans to business, which will increase their growth.

  2. Inflation impact i assume on how good they are at passing on the inflation to us consumers.

#14

Well, I tried to see it in that way … Increasing Money Supply, means there is actually a low interest rate now, which will lead to higher inflation, in response to this high inflation there shall be an increase in interest rate which will negatively effect bonds price