Investors should not be worried about a bubble in the bond market, as the current high prices and low yields in bonds are not driven by the same factors as a classic bubble, said Roger Bridges, head of fixed income at Tyndall AM.
A bubble is when a price level is much higher than is warranted by the fundamentals and by what rational expectations would dictate.
“Bubbles occur when prices continue to rise because enough investors believe that they can buy securities at the current price and then sell them at even higher prices,” said Bridges.
He said there were three main reasons why the current bubble was nothing to worry about:
The flow of money into the bond market is not being fuelled by greed, as is the case in a classic bubble scenario, but by flight-to-safety.
“Foreign investment is also playing a huge role in the price of Australian bonds. Before the global financial crisis (GFC), approximately 20-30% of Australian government bonds were held offshore. By 2012, this number had jumped to around 80%.”
Loose monetary policy in other developed economies is driving demand for our bonds.
Central banks around the world (the main three being the US, Japan
, and the UK) are attempting to boost growth in their nations and accelerate economic recovery by using quantitative easing (QE). This means increased demand for Australia’s higher yielding assets.
Investors are not looking to sell their bond investments any time soon.
“Despite recent rate cuts, Australia’s government bonds remain the highest-yielding AAA rated assets in the world. Prices for our Commonwealth government bonds may be historically high and yields historically low, but compared with the rest of the developed world they remain attractive.
“In the near to medium term, Australian bonds will remain attractive,” said Bridges, “With the US and France losing their AAA status and several of the remaining AAA rated countries looking shaky, Australia’s position is stronger than ever.”