The Bond Bull Market

Fixed income is the industry that handles investment vehicles with fixed payments given back to investors. With the markets fluctuating, investors are jumping the bond bandwagon, with the security of guaranteed yields. This has recently turned the bond market into a bull run. Investors are putting their safe bets on fixed income investments. Treasury prices are soaring, and due to the inverse nature of bond prices to yields, yields are at historic lows.

The Proposed Question: Is it really the safest option?

Now the perceptive reader may ask, “If prices keep going up, then yields are going down and stop becoming attractive. If people sell their position for other investments, will people are those left in the market lose money?”

The answer is yes. This bull bond market can effectively cause losses in one’s portfolio. Imagine the situation where a retired senior watches his 401(k) hit the floor due to the equity market failure. He believes bonds will be better place and allocates a majority of his portfolio to bonds. This oversaturated bond market then loses public appeal and investors clear out. Prices drop and the retired gentleman is left with even less money in his portfolio than when he started. At least he still gets a marginal coupon back every disbursement period, right? The point is, increased risk has been introduced to this market.

Good indicators on the increased riskiness of an investment vehicle are the players in the market. Hedge Funds recognized for their risky approach to investing in order to meet high return demands by investors have been in the Fixed Income arena. The HFRI, a Hedge Fund index, shows that Hedge funds that focused on Corporate Debt gained 4.76% in this half-year. Asset-Backed Fixed Income Hedge Funds returned over 6.36% in six months. So with hedge funds staking positions, it is positive that once greener pastures are visible, they will be jumping off the fixed income boat. There is very high probability that the bond market will fall.

If one can determine the reasoning behind the positions institutions are taking in debt, one can perceive when they will exit. If the equities market is what Funds are waiting for in order to leave the bond market, what indicators are they looking for in the equity market? A little background information on why the bond market are increasing is actually happening can reveal what may attribute to the conditions that will result in companies leaving and watching the dismal fall of the oversaturated bond market.

A Major Force Behind This Bull Bond Market

Domestically, this bond market fluctuation can be attributed to the deflationary fears of the United States. It is hypothesized that the Fed is caught in a “liquidity trap”; the Fed’s near-zero rates disallow it from enacting typical monetary policy, and with forces beyond the Fed’s control to print new money, they can only watch as capital is conserved by individuals and businesses who are preparing to weather the deflationary storm. Meaning the Fed cannot enforce any changes that will effectively allow the US to dodge deflationary pressure.

Deflation can negatively affect consumers and businesses as debt increases; each dollar owed back is worth more. Companies will have a harder time exporting as their dollar is worth more in comparison to other countries so the US will lose international competiveness. And as many know, the average US consumer is highly leveraged with debt.

Tying It All Together

In short: The bond market will be bullish until all fears of a deflationary environment are calmed. Then companies and funds will devote their time, and more importantly their capital, into the equity markets, easing fixed income to the steady market it has been.

In fact last Friday, Fed Chair Ben Bernanke announced that the Federal Reserve will do anything to ensure that the U.S will stay on track with its recovery process. This is a good first step.

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