In recent years an astonishing amount of money has quietly flooded into fixed income funds, which buy corporate bonds, emerging markets bonds and mortgage debt. And as the US looks more likely to raise interest rates, creating potential losses for bondholders, the flows could reverse – creating destabilising shocks for regulators and investors alike.
Read the whole thing. Pointer from Phil Izzo. My thoughts:
1. The last time I talked about a “bond bubble” was in 2003. Subsequently, I wrote that only a bursting of the bond bubble could undermine high house prices. I was wrong about that one.
2. Larry Summers would explain the “bond bubble” as secular stagnation. In his view, there is low demand for capital. As you know, I have little regard for this thesis.
3. Perhaps I feel burned by the way that the housing bubble burst on its own, but I would not focus on a bursting of the bond bubble as the key risk today. I find myself sympathetic to Seth Klarman on the stock market (Klarman is cited by Tett, and if you search diligently you can find copies of his investor letter posted on the web). I am skeptical of contemporary market arithmetic.
4. Klarman blames the Fed for low interest rates, and so do many people of my ideological stripe. My view is that if the markets wanted high interest rates, they could have them, notwithstanding the Fed’s efforts. Perhaps we now live in a world in which the primary threat to saving comes from political risk. In that world, savers are not looking for the assets with the best financial characteristics. Instead, they are hoping to invest where they will not lose their capital to taxation and confiscation. This might explain why a lot of foreigners still prefer to invest in low-yielding U.S. assets.
But the bottom line is that today’s financial markets have me puzzled.
Not just taxation and confiscation but buying of jobs and fear of investment losses, consistent with stagnation or lack of late stage investments that require much capital. While people may have doubts about monetary stimulus, to have doubts about monetary tightening is to admit that a rise in rates requires large new investment opportunities, so bond losses would be offset by equity gains, while if you believe in monetary tightening, there really can’t be bubble due to inflation or loss of confidence.
But the bottom line is that today’s financial markets have me puzzled.
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Uncertainty in action
Out there question: You say the market could have high interest rates. Sounds awfully subjectivist. Unless that means they don’t see many investments and isn’t that Summer’s position?
Stocks are going to crash, I assume, and that might serve as a catalyst but a bond bubble seems like depression material. If natural rates keep dropping because rois keep dropping how are prior higher rated bonds going to pay off? Wouldn’t they be a wrong bet on a future that isn’t panning out?