There also may have been a second factor at play. A fall in interest rates associated with the rise in central bank purchases of treasuries and agencies would tend to push up the price of all interest sensitive assets, including homes. If new homes can be produced at a lower price that would pull prices back down — but there are lags, and in some places new supply is constrained. the rise in home prices in turn would reduce losses on the generation of risky loans made just before the rise in prices. a borrower that got into financial trouble (say lost a job) could sell the home and pay off the mortgage and perhaps even pocket some cash in a rising market. Lower than expected losses entered into the models used to price/ value potentially risky securities — and contributed to the compression in credit spreads in the mortgage space.

you can argue that markets should be forward looking and recognize that a one off rise in prices increases the risk of subsequent loans barring further price rises, but well, that doesn’t seem to be how the market thought. remember all the talk about how home prices never fall on a nation-wide basis.

You distort the premise of the argument. Nobody said this. PBOC behaviour alone does not determine all bond market pricing.

Concentrated buying of treasuries and agencies by PBOC caused yields to decline in treasuries and agencies, relative to what they would have been.

Concentrated buying of treasuries and agencies by PBOC caused a scarcity of such product available for private sector investment.

Scarcity of treasury and agency product for private sector buying caused the private sector to seek the closest substitutes where it could find them. This created greater demand for credit risk products than would otherwise be the case, starting with the lowest risk product. Dealers assisted in creating lower risk credit with various forms of financial engineering. This effect rippled through the credit pricing spectrum.

Most importantly, at the same time, the general macroeconomic outlook for credit risk was unusually optimistic.

So the correct conclusion is that, notwithstanding the downward pressure put on the general level of interest rates due to PBOC demand for treasuries and agencies, credit spreads still compressed, due to high private sector demand for near substitutes for treasuries and agencies, a buoyant credit risk outlook, and Wall Street engineering.

There’s nothing inconsistent with both trends happening at once. Both put concentrated demand pressure on two different sectors of the market. There’s nothing to say that the pricing of risky credit can’t improve at the same time as the pricing of risk free credit, or that it can’t improve at a faster absolute basis point pace.

An alternative theory which seems to fit the facts better, however, is that a US-generated (eg CDO driven) boom in demand for spread product encouraged more borrowing and more imports of consumer goods. Given the PBoC’s currency peg, this led them to intervene.

Perhaps the Governor of the Bank of Canada is wrong!

Both are facts. Not sure how to respond to doubts about facts.

The reason I’m asking is to see who benefits from yuan inflation. In the US and Europe the newly printed money goes to the government and to the banks giving them the (unfair) monetary inflation benefit. If the PBoC hands the newly printed money to the US importer who uses it to buy for-export goods, those who benefit from monetary inflation are the foreign customers and the Chinese exporters. Very strange.

Rebel. I agree with Anon. Canada’s central bank governor has made a similar argument as well. the invested yield curve of 05-06 in particular generated a lot of demand by private actors for spread products, as you couldn’t make money borrowing short and lending long without taking credit risk. This is when SIVs and the like really took off.

I’m particularly interested on a measure of how much they actually print and how many of newly printed yuan end up the FX market in exchange of dollars.

TIA

So, despite the fact that PBoC bought treasuries, spread product yields fell MORE than treasury yields (ie spreads narrowed)?