1994 bond market crisis
[3] After the recession of the early 1990s, historically low interest rates in many industrialized nations preceded an unexpectedly volatile year for bond investors, including those that held on to mortgage debts.
Some financial observers argued that the plummet in bond prices was triggered by the Federal Reserve's decision to raise rates by 25 basis points in February, in a move to counter inflation.
[6] As late as January 1994, President of the Standard & Poor's Index Leo O'Neill noted how, despite the fact that the majority of junk bonds issued by the corporate sector had earned upgrades for the first time since 1980, the dollar value of those that had been downgraded actually exceeded these by more than $110 billion.
[7] He warned that overconfidence in the economy would permeate the markets much as it did prior to Black Monday in 1987, and worried that any contractionary moves by the Fed would significantly depress the returns on bond funds.
[6] He suggested that President Bill Clinton's signing of the Omnibus Budget Reconciliation Act of 1993 would be a "favorable backdrop" for investors by providing additional downward pressure on future interest rates, thereby raising bond prices over time.
[6] The immediate trigger of the crash in the US occurred at the Federal Open Market Committee (FOMC) on February 3 and 4, 1994, although bond prices in Japan had started plummeting just a month earlier.
Starting in March, as the bond market's newfound turbulence became more settled in investors' minds worldwide, homeowners were discouraged from refinancing their properties further due to the rise in long-term rates.
In the Journal of Macroeconomics, Associate Professor Willem Thorbecke of George Mason University hypothesized that inflation worries, in conjunction with confusions over the Fed's next monetary move, contributed to the drop in bond prices within the US.
According to a report published by the Bank for International Settlements (BIS) a year after the crash, a rise in realized money market instability corresponded with a similar increase in implied volatility for bond yields.
Along with Securities and Exchange Commission (SEC) Chairman Arthur Levitt Jr., they accused hedge funds of irresponsibly speculating on long lines of credit, despite being at odds over whether they needed additional regulations.
[8] The inordinate decline in bond returns prompted some financial observers to compare the crash to Black Monday several years earlier for witnessing almost the same spillover effect internationally.
[1] Across continental Europe, a decline in international capital flows further aggravated the markets' turbulence and prompted foreign investors, including financial firms located in the UK, to sell off their bonds.
[8] The joint destabilization of its money and bond markets was further exacerbated by the yen's appreciation, which shifted expectations on consumer prices and short-term rates, and brought with it nationwide deflation.
Starting in the late 1980s, enthusiasm among Mexican investors soared amid the rapid pace of financial liberalization following Mexico's decision to abandon import substitution industrialization (ISI) and peg the peso to the US dollar.
[16] Combined with excessive borrowing to maintain a strong peso under the peg policy and the assassination of Institutional Revolutionary Party (PRI) presidential candidate Luis Donaldo Colosio Murrieta, these factors destabilized Mexico's financial markets.
[19] Upon witnessing their 1994 losses, some observers argued that investors' reactions shortly after the US's first monetary contraction of that year discouraged the Fed from acting too aggressively in raising interest rates later on.
[3] In light of this monetary transition however, RBS Securities head of North America sales Richard Tang predicted that any cessation in QE would make investors anxious over the chances for future rate hikes.
[2] Amid the prolonged periods of near-zero rates, PIMCO managing director Scott Mather argued that investors would continue buying bonds with low yields along with riskier assets to diversify their portfolios, but warned about the potential "unwinding" that would ensue once the QE rounds expired.
