Financial Times Editorial: A bond market feeding frenzy

A bond market feeding frenzy
Published: March 5 2005 02:00 | Last updated: March 5 2005 02:00
Financial Times Editorial

This is a great time to issue bonds. Over the past couple of weeks, investors have been falling over themselves to snap up new offerings, whether they be long dated or short term, high yield or sovereign.

Beneficiaries of this feeding frenzy have included the French government, which became the first from the Group of Seven leading industrialised countries to issue a 50-year bond. The issue, which will run for 20 years longer than any previous French government bond in modern times, was increased to €6bn (£4.1bn), having attracted orders for more than three times that amount. In what must count as a triumph of hope over experience for anyone with the slightest recollection of how inflation can suddenly take hold, it was priced to yield just 4.21 per cent a year.

Greece, still fresh in the memory for credit-rating downgrades and for having entered the eurozone on the basis of dodgy economic statistics, was able this week to bump up to €5bn the size of its first ever 30-year bond.

In the US, Centex, a US housebuilder, sold $1bn of asset-backed paper and was rewarded with best ever prices. The tranche maturing after one year yielded a record low of seven basis points, or seven-hundredths of 1 per cent, over the one-month London Interbank Offered Rate (Libor).

The yield spread, or premium over government bonds, of emerging market debt has shrunk dramatically. That of many corporate bonds has fallen to levels last seen in 1998, just before the collapse of Long-Term Capital Management, a hedge fund, plunged the world into a big financial crisis.

Bond yields have been falling while the US Federal Reserve and other central banks, such as the Bank of England, have been raising their short-term rates. It is difficult to explain the falling yields, which have brought real yields after adjustment for inflation to unusually low levels, by developments in the global economy. Despite high and recently rising oil prices, world economic activity is expanding at a reasonable pace.

It is little wonder that Alan Greenspan, Fed chairman, spoke last month of a bond market "conundrum". One could go further and argue that bond markets are falling prey to irrational exuberance similar to that seen in equity markets before the dotcom bust.

If so, one unpalatable conclusion is that we are living through a bond market bubble. Indeed, the frothiness of bond markets may be just one more symptom of an ongoing asset-price bubble that has already affected housing in the UK, the US, Australia and the more vibrant parts of the eurozone such as Spain. A common factor behind the asset-price inflation is the strong growth of liquidity produced by the central banks of the US, Japan and Europe in recent years.

It is a world in which psychology and perceptions can change with lightning speed. It can be very rewarding for the professionals in investment banks and hedge funds that choose to ride this tiger. They should be left to get on with it, provided they are equally equipped to pay for the risks taken.

But what of the private investor? The prevailing environment, with low inflation and low returns on conventional investments, is fraught with hazard. The unwary, seeking returns that would have been modest until a few years ago, may underestimate the risks involved. Like equities, bonds and bond-related investments can go down as well as up. In today's market, the watchwords must be Caveat Investor.

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Prudent Investor comments:

Debts, debts and more debts contribute to the fast exploding global liquidity. With bond prices rallying in the face of interest rate hikes and narrowing spreads, investors are fostering asset bubbles globally in the chase of higher returns. This poses as an accident waiting to happen.