Bond Market and Bubble

Bond prices these days are up and their yields are at record lows. This is true for both government and company bonds. Investors have put in money into bond funds and bonds. They are afraid to invest fully into the stock market.

Scary possibility

September was a month of a small scare when prices of bonds suddenly dipped due to concerns that Federal Reserve along with a number of central banks could end “easy money” policies. That fear, however, was short lived as investors quickly convinced themselves that the Federal Reserve will proceed slowly when it comes to raising the rates. There was a subsequent recovery in the bond prices.

Analysts have now broken into two camps. One camp argues that there will soon be a burst in the valuation bubble, while the other camp believes that this is yet another false alarm. Alarms like these are heard often but happens only rarely. Robert C. Pozen of MIT Sloan School of Management is firmly on the former camp. He has argued that the market is in a bubble as investors are hungry for yields and thus get attracted towards the riskier bonds. Guy LeBas of Janney Montgomery Scott, on the other hand, said that he does not believe that there are any credit excesses which would make this market a bubble.

For bubble

Pozen predicts that bonds will lose substantial value for almost all major bonds within end 2017. He said that prices of bonds are in a bubble not only for historic low bond yields, but also as the investors get attracted towards longer term and lower quality bonds carrying higher risks. Investors will exit when such risks will be realities. This will reduce the liquidity and also further depress the prices of bonds. In case of the bubble getting deflated, holders of bonds will suffer extensive declines in the present values of the bond portfolios.

Against bubble

LeBas, on the other hand, believes there is no bubble in the bond market. He said that the nature of bonds dictate that they have dates of maturity. This is a time in the future when the security will be worth a certain sum of money. Thus it is impossible for the bond value to be progressively more when moving forward. It is thus not possible for any individual bond, and the complete bond market to exist in a bubble.

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