The Financial Times points out all the worrying developments in bond markets: more and more bonds with a negative yield and rising risk for default and liquidity risks for fixed-income funds. Mary Pieterse-Bloem, Endowed Professor of Financial Markets at Erasmus School of Economics, analysis possible bubbles in the bond market.
'Financial bubbles share the trait that the price of an investment lays far above or beyond the fundamental value', says Pieterse-Bloem. 'Examples are the 2001 dotcom-bubble and the 2005 housing market-bubble which led to the financial crisis in 2008. The bubbles have in common that the prices increase because of irrational behaviour of investors.'
Mary Pieterse-Bloem states that we deal with three possible bond bubbles right now. 'The first possible bubble can be found in developed country government bonds. The prices reflect the purest interest risk, except in case of a bubble. Than interest does no longer reflect the underlying dynamics of the economy. The second possibility can be found in the market for corporate bonds, which, in addition to interest, are driven by the cash position of companies. We speak of a bubble when the price of financing does not adequately reflect the risk of non-payment. This bubble bursts when the economy is in recession and companies are no longer able to meet their obligations on a large scale. Lastly there's another possible bubble in emerging market bonds. In the case of a bubble, these countries loan at a too low cost.'
According to Pieterse-Bloem we should not fear all possible bond bubbles. ‘If there are any bond bubbles, particular attention should be paid to high yield- and emerging market bonds.’
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Read the entire column on IEX Profs, 30 October 2019 (in Dutch).