Bubble and Squeak! Yes that sums up the investment markets at the moment.
Here is a Ten Point Guide to what it all means…
1. A Bond is effectively a loan. Governments, Businesses, Local Councils and even Private Contractors need money to pay for projects.
2. They get it by borrowing from investors who get a rate of interest and a date when they will get repaid.
3. These interest rates and dates vary and, of course, the greater the risk of not getting repaid felt by the investor the more generous the interest rate will need to be to tempt them.
4. So, at the moment people are nervous about where to put their money – so are big investment funds like pension schemes and charities.
5. Poor news from the US suggests that there may not be very good returns on stocks and shares or more risky bonds so they are all buying the safest bond of all – US treasuries!
6. However, there are not always US Treasuries for sale – so you may have to buy yours from the market. That will be one where the rate of interest and pay-back date (redemption) is already agreed…and if that rate of interest is good, compared to whatever is on offer now, then you may have to pay a bit more than the owner did for that bond, which means your actual rate of interest may be less than the face value.
7. This is what commentators mean when they say the “yield” on US treasuries has fallen or the “Yield” on Gilts (the UK version) has fallen. They actually mean that the value of these bonds has increased if you want to buy them so what you will receive in interest, as a percentage of what you paid for the bond, has reduced.
8. So Bond values rise and yields fall, Bond values fall and yields rise – simple!
9. Why does the value fluctuate? Well – supply and demand like everything else! When do people want Bonds? Well…when the rates look good, when they need a fixed income (retirement funds etc) or when everything else looks lousy!
10. So is there a Bond Bubble now? Well, anyone buying a US treasury with a yield of 2.8% must expect interest rates to stay low for a while and inflation to be gentle – as well as equities remaining flat. If any of those things change then Bond values will fall very quickly and many investors will lose the capital value of the bonds they have bought. Yes, it probably will happen…
Beware the words that always spell disaster…”This Time It’s Different”
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