Roger Bootle: When the bond bubble finally bursts, a lot of investors will get hurt
My thanks to a subscriber for drawing my
attention to this excellent
article on the UK bond market, published by The Telegraph. Here is the opening
Two weeks ago, I suggested that the bond market was caught up in a serious bubble and that its potential bursting represented the greatest threat to financial stability. Since then, bond markets here and abroad have indeed been weak. But you ain't seen nothin' yet.
True, this isn't a bubble in the classic sense of markets holding unrealistic expectations (as they did, for instance, during the dotcom boom). It arises as a result of the correct perception of official policy. But the extent of the distortion this has caused in the bond markets is quite remarkable.
n the 1950s and 1960s, UK government bond (gilt) yields had averaged about 5pc. There had been periods when gilt yields had been much lower, for instance in the Great Depression of the 1930s. But not as low as now. At the recent trough, yields dropped as low as 1.5pc. Even after the recent bond weakness, UK 10-year yields are still only about 2pc.
Index-linked bonds currently present the most remarkable features. For most of their history, such "linkers" have yielded between 2pc and 4pc after inflation, that is, in real terms. Recently, however, real yields have been negative. That's right, investors have willingly held them at yields which are bound to lose money in real terms. And investors even have to pay tax on the interest.
So what is going to happen? What the appropriate level of interest rates and bond yields should be when things have returned to normal will depend crucially upon inflation. If inflation is expected to run at something like 2pc, then we can expect conventional long bonds to yield between 4pc and 6pc.
David Fuller's view Since UK inflation has been mostly above
2% throughout the credit crisis recession, for it to remain at that level during
a genuine economic recovery would certainly be a best case scenario. While UK
10yr Gilts (historic monthly
& weekly) have not been above the
4% to 6% range mentioned by Roger Bootle since 1998, in the next period of sustained
global economic strength they could easily rise higher.
See also
last Friday's Comment: The
Bond Invesor's Dilemma…