Bonds: the greatest bull market of all time gets even frothier
Many of us thought it would come to an end years ago but we’vee been humiliated by reality
A trader looks at screens at a bank in Lisbon . Photograph: Hugo Correia/Reuters
Bubble spotting is a favourite activity of market commentators. A real estate bubble is thought to be popping in China and another property bubble is forming in the UK. Equities, particularly in the US, are widely described as overvalued - some argue by up to 70 per cent, which must also count as another bubble. But the frothiest market of all, the biggest bubble, is that for bonds.
Global bond markets seem to go up every day. That’s the same thing as saying bond yields continue to fall, something they have been doing, on and off, since 1982. It has been one of the greatest bull markets of all time. Many of us thought it would come to an end years ago but, like all forecasters, we have been humiliated by reality.
Bonds are more important than any other financial asset. We obsess over the ECB policy rate, the euro and house prices. Bond yields are way more important than any of these, not least because, bonds actually shape these other asset prices.
Bond yields determine pretty much anything: from the price of agricultural land to the value of Apple shares, a bond yield is lurking somewhere in the background. Bonds will, to a considerable extent, drive how much tax we pay in the future; they will dwarf the significance of water or property taxes. The next time an expert talks about where Irish house prices are likely to go, notice that he will never mention the outlook for bonds. This is like forecasting the weather without reference to wind, sun or rain.
Bonds are not sexy. Yet fixed income traders make the most money. It has long been the case that there is more money to be made in bonds that equities. Bond traders have been earning big bonuses for far longer than ordinary bankers. Some investment banks have, curiously, been reporting lower profits in their bond divisions. Given the ongoing bull market it might be that their traders, like the analysts, have been betting, incorrectly so far, that bonds are due for a fall.
Yet, bond markets rarely figure very much in the popular financial media. We know who some bond holders are, of course, since Jean-Claude Trichet refused to allow us to immolate them. The ECB’s decision to protect European bankers from the mob lurking on Europe’s periphery was both unexplained and temporary. But we will be paying the financial price of this for centuries to come.
Unusually, bonds are making popular headlines today; breathless commentators rejoice at the sight of Ireland’s borrowing costs, our bond yields, falling below those of the UK, as if it was a contest taking place in the Aviva stadium. Somehow it doesn’t feel quite as gladiatorial, quite as satisfying, when our yields threaten to go below those in the US.
Analysts are struggling to rationalise the behaviour of bond markets. And, therefore, the behaviour of pretty much every other asset price. The first part of the great bond bull market, the bit that encompassed the 1980s and 90s, was all about a secular fall in inflation. Central banks everywhere discovered their mojo and brought inflation down. This had a corresponding impact on bond prices. More recently, two related themes seem to be driving bond prices higher.
First, some economists think we have entered a period of secular stagnation: prolonged low growth and minimal inflation. Growth and inflation prospects determine bond yields. Second, in order to boost economic prospects, US, Japanese and UK Central bankers have been buying bonds hand over fist. There is, of course, much speculation about when the ECB will join the party - Mario Draghi talks a lot but, so far, has done little, engaging in remarkably effective quantitative teasing.
That ECB talk is the prime driver of the all-time lows seen recently in Irish bond yields. There might be celebrations about this but the dark side is that the market’s message is that the growth outlook is poor. This could change in a heartbeat. If subdued growth expectations change to a forecast of outright recession, solvency risk will rise again. Bond markets will worry about our ability to pay the money back. If growth expectations rise, bond yields will also shift upwards.
In a rational world, one not ruled by the the ECB, governments facing ultra low borrowing costs would be advised to tap the markets for all they can. We should borrow for capital projects that are deemed likely to yield more than the cost of the bonds that we issue. And there are plenty of likely candidates for such investment. Our masters do not trust us to do this, believing that feckless countries will borrow only to splurge on wasteful spending. The sad reality is that they are right not to trust us. Democratic, it ain’t. But it is, as they say, where we are.