The Federal Reserve has been a large purchaser of US treasury securities. That has kept the price of safe US bonds relatively high, and the yields from those securities relatively low. Hedge funds, bond funds and private equity funds have looked elsewhere in search of higher yields for the $1.5 trillion flow into bond funds over the last 5 years. They have been large purchasers of higher yielding, but riskier bonds, issued in emerging markets by private enterprises. The total outstanding bond debt in emerging markets now totals around $2 trillion. The funding of emerging market debt has shifted from commercial bank lending to bond issues over this period. Prior to quantitative easing, commercial bank lending was twice the size of bond funding in emerging markets. Over the last five years bond issuance has surpassed the use of commercial bank lending to fund private investments in emerging markets.
This article raises two concerns about the shift from commercial bank lending to the use of bonds to fund private projects in emerging market. The first concern is the risk of a liquidity crunch. The rush into emerging markets by bond funds has the appearance of herd behavior. The risk is that they may all attempt to exit the market at the same time. Commercial banks have a longer term time horizon than bond funds. The second concern follows from the liquidity concern. The global economy has become dependent upon growth in the emerging market economies. A reversal of the flow of funds into emerging market economies would have global implications.
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