Many financial analysts are now saying that a bubble has developed in the bond market. A financial bubble like this occurs when the prices of a similar group of securities rise to a level where the benefit of owning those securities no longer adequately compensate investors for the costs and risks that come with that ownership.
The CFA Institute Financial NewsBrief took a recent poll of 815 financial analysts, and nearly 90% said that they believe that at least some portion of the global bond market is experiencing this type of bubble right now. About a third believe that all bonds are in a bubble, while a quarter believe that sovereign bonds are bubbling. However, only about 15% believe that high-yield bonds are in a bubble. (For more, see: 5 Steps of a Bubble.)
Much of the cause of this bubble can be attributed to the central banks of several countries that have pursued an aggressive bond buying policy since the subprime mortgage meltdown of 2008. The Federal Reserve has ceased its quantitative easing operations for the time being, but Japan may be increasing theirs, and the European Central Bank just raised its bond buying level from 60 billion euros to 80 billion per month. This continued level of demand from these banks has effectively pushed bond prices to a level where analysts feel that they are substantially overpriced. The Fed’s inability to raise rates has also contributed to their current price level.
Needless to say, the current low rate environment has made it difficult for bond portfolio managers to generate yield. Some fund managers are taking creative approaches to generating returns, such as PIMCO, which is buying Japanese bonds that have negative yields and then locking in exchange rates using swaps. This effectively quadruples the yield on long-only U.S. bonds with similar durations.
In order for bond prices to return to what analysts consider market levels, there needs to be an economic factor that counteracts the actions of the central banks. Until that happens, bond investors can expect to continue receiving negative yields. (For more, see: Five of the Largest Asset Bubbles in History.)