CHAPTER 0
Overview

0.1 GLOBAL FIXED INCOME MARKETS

Fixed income markets are large and global. Figure 0.1 shows the outstanding amounts of debt securities, by residence of issuer. Debt securities are instruments designed to be traded, like bonds issued by corporations or by governments. Grouping by residence of issuer means, for example, that US Treasury bonds held by China's central bank are included in the total for the United States. As of March 2021, the global total of outstanding debt securities was about $123 trillion. For reference, the total capitalization of global equity markets at the time was $110 trillion, although stock market values are significantly more volatile.

Figure 0.1 shows that the five largest issuers, in terms of amounts outstanding, are in the United States, the Eurozone, China, Japan, and the United Kingdom, which together comprise nearly 90% of the total. The Eurozone includes countries that both belong to the European Union (EU) and use the euro as a national currency. Some individual members of the Eurozone, indicated with asterisks in the figure, are significant issuers of debt securities on their own. Note that the figure displays their amounts outstanding with gray bars, but their contributions to the cumulative total are included once, with the Eurozone total.

Figure 0.2 decomposes debt outstanding in the five largest regions by sector. The large fraction of government debt in Japan reflects decades of government borrowing and spending intended to stimulate the economy. The fraction of government debt in the United States, the Eurozone, and the United Kingdom is lower, at about 50%, but has increased significantly since the financial crisis of 2007-2009. Corporations in the United States are relatively more likely to issue bonds directly to the public, while corporations in the Eurozone, Japan, and the United Kingdom are relatively more likely to borrow funds from intermediaries, like banks, which, in turn, raise money from the public. While Figure 0.2 includes the breakdown for debt in China, the relatively large role of the government in financial and nonfinancial enterprises makes comparisons across sectors and regions less meaningful.

FIGURE 0.1 Global Debt Securities Outstanding, by Residence of Issuer, as of March 2021. Countries with an Asterisk Are in the Eurozone.

Sources: BIS; and Author Calculations.

FIGURE 0.2 Global Debt Securities Outstanding, by Sector, as of March 2021.

Sources: BIS; and Author Calculations.

Table 0.1 and Figure 0.3 show the notional amounts of outstanding interest rate derivatives across the globe. These derivatives are described in later chapters, but derivatives essentially allow market participants to take positions on interest rates, whether for hedging, investment, or speculative purposes. The notional amount of a derivative is used to calculate the cash flows that one of the derivative's counterparties pays the other. Adding together all notional amounts, however, can significantly overstate market size. First, the largest market participants, namely dealers, tend to be simultaneously long and short nearly identical derivatives. Second, options are actually equivalent to only fractions of the notional amounts of their underlying securities. Later chapters elaborate on these points, but, for the purposes of this overview, this table and figure are reported in notional amounts.

While derivatives may trade in a particular locality, there is no sense in which derivatives are issued in one place or another: local regulations aside, any entity, residing anywhere, can enter into these derivatives contracts. A typical classification, therefore, is the currency in which the cash flows of the derivative are denominated. The first two columns of Table 0.1 show notional amounts for swaps, options, and forward rate agreements. Most of the outstanding amounts are denominated in US Dollars (USD) and Euro (EUR). The quantities in the table hint at the overstatement of market size by notional amount: if the sizes of the markets for these USD derivatives were really $150 trillion, they would be larger than the combined size of all global debt securities markets. The second two columns of the table show the notional amounts of standardized, exchange-traded interest rate futures and options. Amounts outstanding of USD-denominated contracts are by far the greatest, with those denominated in British Pounds (GBP) and EUR making up most of the rest of the overall market.

TABLE 0.1 Notional Amounts of Interest Rate Derivatives. Swaps, Options, and FRAs, as of June 2020; Futures and Futures Options, as of December 2020. Entries in $Trillions.

USD: United States Dollar; EUR: Euro; GBP: British Pound; JPY: Japanese Yen; CAD: Canadian Dollar; SEK: Swedish Krona; CHF: Swiss Franc; BRL: Brazilian Real; AUD: Australian Dollar.

Source: BIS.

FIGURE 0.3 Credit Default Swaps, Notional Amounts Outstanding, by Sector and Type, as of June 2020.

Source: BIS.

Finally, Figure 0.3 gives the notional amount of credit default swaps (CDS) outstanding. These are discussed in detail in Chapter 14, but, roughly speaking, CDS allow investors to take positions that are equivalent to leveraged long or short positions in bonds with credit risk. The figure divides the market into credit sectors: CDS can be written on nonfinancial companies, financial companies, sovereigns, asset-backed securities (ABS), and mortgage-backed securities (MBS). Within each sector, a single-name CDS references a single credit (e.g., the government of Spain), while an index CDS references a portfolio of credits (e.g., 25 European financial companies). Note that the CDS market is much smaller in notional amount than the derivatives markets depicted in Table 0.1.

0.2 US MARKETS

This section describes debt and loan instruments in the United States, categorized as in Figure 0.4. The total amount outstanding across all instruments, as of June 2021, was $76.4 trillion.1 By way of comparison, the market capitalization of US equities at the same time was about $45 trillion. Treasury securities and municipal securities are discussed in this section in some detail, while sectors discussed in later chapters of the book are treated very briefly here.

FIGURE 0.4 Debt Securities and Loans in the United States, Amounts Outstanding, as of June 2021. GSE: Government-Sponsored Enterprise.

Sources: Financial Accounts of the United States, Board of Governors of the Federal Reserve System; and Author Calculations.

Treasury Securities

In less than a decade, Treasury securities have grown from the third largest category, behind mortgages and corporate and foreign bonds, to the largest category, at $24.3 trillion. When the US government spends more than it collects in taxes and fees, which has been the case for most of the last 50 years, it needs to borrow money to fund its deficit spending. It does so through the array of instruments shown in Figure 0.5. Treasury bills or T-bills mature in one year or less and are discount securities, which means that they sell for less than, or at a discount from, their promised payment at maturity. Treasury notes and bonds are coupon-bearing securities; that is, they earn a fixed coupon or interest rate on their principal, face, or par amounts through maturity, and then repay that principal amount at maturity. Strictly speaking, and in the accounts of the government, notes are issued with 10 or fewer years to maturity, while bonds are issued with more than 10 years to maturity. The distinction had more meaning historically, when bonds were subject to a maximum, statutory rate of interest. In common parlance today, however, the words "notes" and "bonds" are used interchangeably. In any case, Chapter 1 describes the cash flows of Treasury notes and bonds in more detail.

FIGURE 0.5 US Treasury Obligations, Amounts Outstanding, as of June 2021.

Source: US Treasury...