Emerging Markets / November 4, 2016

Current and Emerging Financial Instruments

Earlier this week the Federal Open Market Committee (FOMC) of the Federal Reserve held its scheduled November meeting to discuss economic progress and monetary policy in the United States. Less than a week away from the presidential election, it is not surprising that the FOMC decided to maintain the federal funds interest rate between 0.25% and 0.5%. Nevertheless, the official statement put out by the Committee does recognize the macroeconomic advances of the US economy over the last few months. The FOMC mentioned that the overall economy has continued its slow growth during the last several weeks and that there have been important gains within the labor market, which have lowered unemployment. Similarly, the statement recognized that, even though inflation is still below the 2.0% target rate, it has slightly increased during the last few weeks.

Current and Emerging Financial Instruments

This article explores the current and ongoing status of financial markets worldwide as well as investment instruments. Since 2008, Western nations, particularly in Europe, have implemented economic measures such as quantitative easing and the lowering of interest rates in an attempt to jumpstart their economies. Given the low growth and the almost negative interest rates that have prevailed over the last several years, private and institutional investors, such as retirement funds, have turned away from bond markets into stocks and other unconventional investment instruments. At the same time, in order to maintain their competitiveness, state governments have been forced to reinvent their bond offerings. One measure that governments have taken has been to dramatically extend the life of their sovereign debt.

This extension in the duration of government bond maturity is directly related to the fact that short-term yields struggle to compensate for inflation. Therefore, in order for these instruments to be attractive for investors, state governments seek to highlight the long-term yield of their sovereign debt. For example, during October 2016, Austria issued over US$2 billion worth of sovereign debt at 70 years maturity. Similarly, the governments of France, Spain, Belgium, and Italy have issued debt at 50 years of maturity, with the bulk of the appreciation occurring in the latter years of the bond’s lifetime. This dynamic also allows governments to lock in moderate interest rates, which they expect to surpass through economic growth during the coming decades. In the case of Italy, the national government has issued sovereign debt this year with a yield of 2.2% over a 50-year period. Overall, the issuance of government debt with a maturity of more than 30 years has gone up over 150% throughout the last year.

Meanwhile, international investors are turning to emerging market instruments in the search for higher financial yields. An emerging region with attractive sovereign debt investments is the Persian Gulf. Given the low prices in the international petroleum markets over the last several years, many oil monarchies have resorted to issuing sovereign debt. Even though this move is unprecedented for some of these governments, bonds issued by petroleum monarchies are considered an emerging safe investment given that they are backed by oil reserves.

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