Bond Bubble

Ben-Bernanke1

The Bond Bubble is Bursting – Welcome to Reality

By Sean Garman

The past month has seen equity markets tumble and bond yields rise with “fear” returning to the financial markets all because the Federal Reserve Chairman Ben Bernanke in the US mentioned that the QE programme will eventually taper off. This is a welcome dose of reality to the financial markets and to the political class here in Britain and abroad. Central banks around the world have been distorting markets with cheap credit, providing plaster to cover the cracks of domestic and international economic performance.

Luckily companies have taken advantage of the search for yield amongst investors and consequently waves of refinancings have taken place. I think that this is a net positive for the economy as it allows companies to lock in lower interest payments and push out repaying debt: with this additional breathing space they can more adequately plan and invest. This is one of the positive things that QE was meant to bring out during a “Balance Sheet” recession like the one we have just had. It is a pity that the foresight of many medium and large companies was not replicated by households, Governments and many other investors.

Ultra-low bond yields meant that many investors have surged into the equity and high yield bond markets looking for any kind of return available. This distorts the financial markets with liquidity driving prices rather than a considered view of the underlying riskreturn of the asset. When US “junk” bonds have yields approach 5 % you know that the market distortion has reached new levels of absurdity.

Unlike the tech bubble of the late ‘90s and early ‘00’s where the spurt of investment in technology and telecommunication companies resulted in massive uplift in physical infrastructure (think of the rolling out of fibre optic cabling and improved internet speeds) this asset-price bubble has not resulted in anything like that type of capex uplift. So we are now in a territory partly reminiscent of previous bubbles where risk assets are mispriced but with very little by way of physical assets.

Turning off the monetary taps is the “Emperor has no clothes” moment. One of the common refrains from George Osborne is that the low bond yields are due to the “tough” fiscal policy that the Coalition has adopted. This fig leaf is being pulled away now that yields are steadily rising, and it may force the Government to confront their “ringfenced” public spending commitments, regulatory red tape and generally anti-capitalist rhetoric. We wasted the opportunity to reform when money was cheap so now that it is more expensive it may mean that we have to make the necessary changes.

The era of ultra-loose monetary policy has not ended, yet, but the events over the past few weeks represent the start of a shift in our economy. In the financial services industry it means that the bond bubble has burst and the thirty year bond bull market has come to an end. In society it means that savers will be rewarded for being thrifty, while those who have failed to take advantage of low interest rates will be punished. This is the new normal: a return to reality.

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