The state of the fixed-income market has money management executives split, with some warning that bonds are in bubble territory and others thinking there is less need for concern.
Some investment executives think bonds are at an inflection point, potentially bringing more than three decades of a bull market to an end. Others are less convinced that this is the case, arguing that the underlying enemies of bonds are not strong enough to put the bull market into reverse.
The potential for a bubble was highlighted recently by the CFA Society of the U.K., whose members said in response to a poll in September that global bonds are overvalued. The proportion of those viewing government bonds as overpriced increased to 82% in the third quarter, compared with 75% in the second quarter and 67% in the first quarter.
Corporate bonds also are considered overvalued, at their highest level in three years of the society's index, with 78% agreeing the asset class is overvalued. That compares with 69% in the second quarter, and 58% in the first.
Sources working at money management firms said a combination of factors is fueling the debate around the inflection point. A rapid sell-off in bond markets, particularly in the U.K. and Japan, over the past few months is one factor. Another is the ever-louder call from all corners of the financial markets — including central banks — for the burden of stimulating economies to move to fiscal measures from monetary policy.
And then there's the bond rally of 2016.
“One of the reasons we are having this debate is fixed-income markets have had a tremendous year so far,” said Nicholas J. Gartside, London-based managing director, international chief investment officer, global fixed income, currency and commodities at J.P. Morgan Asset Management. “U.S. Treasuries have returned about 4.5%. If you think back to the start of the year, no one would have predicted that. German government bunds have returned 5.5%, and the (U.K.) gilt index is up nearly 12%. So even the most boring fixed-income markets have had a tremendous run, and that has crystallized a lot of concerns as we approach year-end.”
Profit-taking in bond markets after this performance is realistic, he said, and it is necessary to differentiate between tactical and strategic views. “It may well be that bond yields drift a little higher, and ultimately that is a correction, not a reversal.”
The reason for his hesitancy in declaring this an inflection point is that the two “enemies” of bonds — stronger growth and inflation — are not threats in the markets. “If you have both of those things you have an environment where central banks have to raise interest rates as economies are overheating,” Mr. Gartside said. “But when you look at growth and inflation, it is very difficult to say either of those is exuberant.”
Northern Trust Asset Management's David Blake, director international fixed income in London, said the firm doesn't believe bonds are in bubble territory. And even if they were in a bubble, he said he cannot see the pin that would pop it.