Bonds:the next bubble?

24 January 2009 - Julius Cobbett

This week, two asset managers released bearish commentary on bonds. Allan Gray’s Ian Liddle asks if government bonds are in a bubble. Judging by the recent fall in yields on U.S. 10-year government bonds to a low of 2,1%, Mr Market believes that policymakers will tighten monetary policy in time to prevent large-scale inflation, says Uddle.

Perhaps this places more faith in bureaucrats than is warranted. When you buy a bond, you are locking in a return over a number of years. Thus, bond investors are terribly afraid of inflation. For example, if U.S. inflation is higher than 2,1% over the next 10 years, investors in government bonds will actually end up poorer once their bonds mature. Uddle hints that it might be a bit much to expect U.S. inflation to be low. He asks if the U.S. policy of printing money to solve its economic problems is much different to what the Mugabe regime did in Zimbabwe.

The dollar is still the world’s reserve currency, so Americans can get away with ‘quantitative easing’ or money-printing for longer than the Zimbabweans could - but not indefinitely, he warns. Given the risks to the real value of paper money and the aggressive fiscal stimuli being employed by most governments, some investors are starting to question whether the current very low bond yields provide sufficient compensation for the risks. Fund managers at Coronation Fund Managers had equally bearish remarks. The yield on U.S. 10-year bonds fell close to 2%, while in SA the yields on long dated government bonds have declined to around 7%.

We find these yields totally unattractive, wrote Charles de Kock and Mark le Roux, managers of Coronation’s Balanced Defensive Fund. Instead of holding the unattractive ordinary government bonds, Le Roux and De Kock have gone for South African dollar denominated denominated bonds with an average yield of 9,5% and a U.S. inflation-linked government bond maturing in 2013. They say this bond was bought at a yield of 3,73%. Inflation-linked bonds promise to beat inflation.