David McLeish, Senior Portfolio Manager — Fixed Interest – 30 October, 2019

Interest rates, both home and abroad, have been setting historic lows almost weekly for the last eighteen months.  This has profound implications for us all.  It is for this reason; we are writing a series of articles that we will share with you over the next few months to address the most prominent aspects of this momentous move. We hope you find these articles informative and enjoyable to read.

Bubble Shbubble

Talk of a bond market bubble has crept back into mainstream media of late.  In some respects, this is a natural reaction to what has been a remarkable move in this typically stable asset class.  But what I will endeavor to explain below is that even a rather high-level assessment of the situation suggests these claims are very likely misguided.

 A bond bubble is not what you might think it is.

Bond prices mostly have an inverse relationship to the prevailing interest rate in an economy.  So what bond bubble advocates are saying is that interest rates are somehow materially below the level that can be justified by normal fundamental supply and demand factors.

Take a moment to let that sink in.  This is not some esoteric ‘asset’ like tulip bulbs* we’re talking about here.  They are suggesting the cost of money itself is now meaningfully wrong.

Evidence of a bond bubble would be everywhere, as interest rates impact the value of everything.

If the cost of money really was too low, then everyone would be falling over themselves to borrow it.  This is clearly not what is happening, even in countries that have negative interest rates!  If money really was too cheap then investment and consumption would be booming.

Money is also the means by which we measure the value of almost every good and service in the world.  So if there really was a bond bubble we would almost certainly also have an ‘everything bubble’.  This as people would race out and exchange their less valuable cash for other assets.  After a while of this, the price of all those other assets would be so inflated they would also be in a bubble.