As fixed income struggled with tightening credit spreads, low government bond yields and uncertainty over inflation and interest rate rises, there has been talk of a ‘bond bubble’ – but is there really such a thing?
James Vokins, credit portfolio manager at Aviva Investors, notes that in the past five years the western world has had to pursue looser monetary policy to hang on to growth. With lots of liquidity in the financial system, “that has led to the market moving from bubble to bubble”.
But he adds: “What’s interesting about that is that it doesn’t necessarily mean a bubble has to burst, the fact is the bubble can just continue as it is until we get an orderly unwind or it moves onto something else.”
The manager notes that monetary policy will remain very loose for the foreseeable future as the level of debt in western markets is still substantial and for it to reduce or be sustainable requires growth and inflation.
“The best way to avoid a bubble is for the US and global economy generally to have a very strong year from a growth perspective, and for data to be strong enough to withstand tapering and the inevitably higher yields that would bring. If they manage to communicate the tapering cycle effectively, and keep it in a very orderly fashion, I think that will lead to a very orderly yield increase but not in a panic burst, bubble-burst type way.”
David Thornton, director, Premier Multi-Asset funds, notes there is less of a bubble in high yield, which is more “mid-cycle”, but does highlight concerns about the short-dated high-yield sector where there has been a lot of demand for these types of assets and it has “driven prices probably beyond where they would normally be”.
Nick Hayes, manager of the Axa WF Global Strategic Bonds fund, points out that a bubble requires valuations that do not justify any kind of reality, valuations that do not back the underlying asset and when the bubble ‘bursts’, there are negative returns or people not getting their cash back.
“I find it slightly disingenuous to talk about a government bond bubble, I would agree that valuations are stretched, but I struggle to associate that with a bubble in the truest sense of the word.”
David Tan, head of global rates, international fixed income, JP Morgan Asset Management, adds: “We do not believe there is a bond bubble. This is because there are few signs of high inflation, in particular wage inflation. Even as the unemployment rate has fallen faster than expected, wage inflation has remained quite subdued, suggesting a persistence of labour market slack. Higher bond yields will also help pension funds to de-risk, thereby increasing demand for bonds. So we do not believe that there is a bond bubble nor risk of a bubble burst which will bring about sharply higher bond yields.”
While the jury may be out on whether there is a bubble, where are managers still seeing fixed income opportunities?
