Bonds Are Bigger Than Stocks (2)
The bond market is larger than the stock market. Who usually takes the biggest losses in the stock market? Hedge funds, pension funds, wealthy individuals, or corporations... Those are the ones that come to mind. But the 'players' in the bond market are on a whole different level. Nations themselves sit at the table from the start, with all sorts of massive institutions lurking in the shadows, dipping a toe in whether you notice or not. It's thanks to the stable nature of bonds. So it's not unreasonable to think of them as products that offer slightly higher interest than deposits but come with a bit more risk. That's a fine way to interpret them in normal times.
"So right now, we're straying from that 'normal,' right?"
Exactly.
"You said earlier that the bond market mostly hinges on credit ratings and interest rates..., and rates are about to spike."
If rates rise, the stock market will feel it too, of course. When bonds drop, stocks tend to rise, so stocks should basically go up at first. But they won't fluctuate as wildly as bonds. Stocks are tangled up in everything from company visions to all sorts of economic conditions, but the bond market boils down to just two big factors: credit ratings and interest rates.
"Let me give you a simple analogy. Imagine rock-paper-scissors where you win money if you win, but pay up if you lose or tie. Would you play that game?"
"I'd probably pass. Unless you're really into gambling..."
"What if winning pays 20,000 won, but losing or tying costs 10,000? Or if you're a rock-paper-scissors pro who can guarantee over 50% win rate? How about then?"
Seo Ji-yeon finally tilted her head.
"In that case..., the expected value is the same? It'd depend on the person."
"That's the stock market. Uncertainty acts as a shield in those situations. But bonds? They're different. This isn't rock-paper-scissors—it's like Russian roulette with an automatic pistol."
It's plain as day. Bond prices are determined by formulas that directly include interest rates. It's not some uncertain variable; it's a constant. How much you'll lose, how far it'll drop... It's already half-decided. The moment the US Fed announces a rate hike.
Daeha Investment Bank conference room.
I'd gathered the other directors for a meeting after a long time.
"The US Fed's likely to raise rates. At least 1% over the next year."
Sighs erupted.
"Whew..."
"Haha, looks like it's time to get back to work."
Alpha Fund overshadowed it, but Daeha Investment Bank was no slouch either. With all the future knowledge I had, it would've been weirder if we hadn't been thriving.
"Well..., our country's a closed economy with already high rates, so the impact should be minimal. But other countries will see their currency crises worsen."
Most countries' benchmark rates follow the US. If US rates are high and ours are low, it means higher returns in the US—who'd hold onto local currency? They'd convert to dollars and invest there. But if they follow suit and raise rates, the economy tanks..., and countries already in recession can't handle it. Just look at Japan. They kept ultra-low rates for decades and still suffered massive stagnation. People sometimes think low rates caused the stagnation, but no—it was stagnation that forced the low rates, and it dragged on for decades without resolution. Freezing or cutting rates isn't easy either. Currency value gets wrecked, and you get a foreign exchange crisis. Anyone who lived through our IMF knows how nightmarish that is. Grab one problem, and another pops up—like endless whack-a-mole.
Just thinking about handling that gave me a headache already... The Fed has it good. They only juggle inflation, growth rates, financial markets, exchange rates, US hegemony, money supply, margin requirements, investment bank regs, market integrity, unemployment... Yeah, with all that swaying on one rate decision, it's kinda impressive, right? No wonder the current Fed Chair Greenspan's called the 'Maestro.' If I'd been born in the US, I'd have gone Ivy League, gotten a PhD in econ, and seriously aimed for a Fed board seat. The world economy moving on your call... Ecstasy like that must be unreal.
"...Miss?"
"Huh? Yeah, what?"
Oh crap. I'd zoned out. I slapped my cheeks and cleared my throat.
"Alright, world affairs later. France is mostly wrapped up anyway, which was key. We're focusing on bonds this time."
Director Seo nodded proudly.
"Finally diving into bonds for real. Futures first, right?"
Bonds were huge in scale with low volatility, so they traded mostly via derivatives. No way I'd skip that as a derivatives lover.
"Yeah, trade bonds via futures for now. Interest rate swaps are better for Alpha Fund, so just do futures here."
I handed out a simply structured portfolio to the directors. As always, it was flawless, so they oohed and aahed, showering me with praise.
"You're amazing, Miss!"
"Haha, time to call her President now, you fool."
Hmm.
"Ahaha, President feels a tad off. Makes me sound old. Miss is perfect."
"Ah, yep. Miss it is."
Yeah, yeah, Miss is best. Chairman might work, but President has a weird ring to it.
Ha Young-il was hustling around Wall Street again today.
-"Push swap deals conditioned on rate hikes. Hit a few investment banks, snag deals quick, then bail. Maybe eight at $50 million each... I'll leave that to you."
That was the order.
'Japanese bonds have already dropped a lot, but US folks still mostly expect a freeze. Should get decent terms.'
No doubts. It'd pan out like always.
-"Don't go too aggressive—keep it moderate. We can predict policy direction, but duration's up to human whims."
She added that, sure... But saying at least 1% in a year? Her bar for 'aggressive' was sky-high.
-Click.
"Hmm..., Young. You serious? Betting on rate hikes?"
The IB director asked politely. Lots predicted hikes, but not this fast from year-start.
"You know preparation after the fact is too late. No one's expecting it—think Greenspan's tipping us off? Nah. Rates froze all last year; time to rise."
"...Alpha Fund, who never touched bonds, sure talks big. Another Big Short? That math model predicting bubbles or whatever..."
Ha Young-il smiled subtly.
"Yep. Internally, we see the bond bubble bursting soon. And it's not just math—we analyze rigorously, economically, considering everything."
A sigh.
"Beats me what tricks you're using... But yeah, better prepare."
"So, no swap?"
"Nah. I bet freeze. And..., isn't this insider info bait? Someone tipping traps early."
Scratch. The thick fountain pen streaked black across the paper.
Interest rate swap deal signed.
-Click.
Closing his briefcase, Ha Young-il shook hands.
"Trap? If I weren't Alpha Fund, you'd scoff at my prediction and sign boldly anyway. Isn't that how this game works? Bulls and bears coexist."
"Ha! That's for the clueless. Even you'd flip your portfolio if Greenspan said overheating or recession."
"True."
"Alpha's hit rate's 80-90%. Believe it or not?"
"...You just didn't."
The director shook his head.
"Nah, I did. That's why I signed. Need to short bonds early."
Can't dump bonds blindly without hedges. This swap was the counter-position for risk management.
"Mm..., and I hate eating it alone, so intros to a few others? Citi and Jefferies have equity short teams gearing up—they'll bite. Don't name me."
Ha Young-il wrapped up with a natural, pleased smile.
"Haha, thanks. More deals thanks to you."
"No prob. To unwind bonds now, gotta split volume fast... Getting busy, so I'll head out."
. . .
And February. On the Fed's rate decision day, the unsurprising surprise hit.
As always... She nailed it again.