A bond bubble?
You’ve heard the old saying that fear and greed rule the markets. Well, it’s been mostly fear over the last five years. Desperate for a safe place to put their money, investors have pumped more than a trillion dollars into bonds since 2009. But things may be turning around. This week the research firm TrimTabs said that in January, $77.4 billion flowed out of bonds and into stock funds — that’s more than in any month since February 2000. That’s got people worrying about the bond market, and the possible bursting of a bond bubble. Before you get all fearful again, you should probably hear what Chris Farrell has to say. He’s the Senior Economics correspondent at Marketplace.
“The way I like to think about it, we’re at an inflection point. Stock market, Standard & Poor’s 500 is up 120 percent, more than 120 percent, since its low of 2009. So far this year, it’s up more than 5 percent. There’s individual investors,” says Farrell. “So we seem to be at one of those turning points where people are going to shift attention away from bonds and towards stocks.”
A bond explainer by Paddy Hirsch
What is a bond? A bond is essentially a loan. If a company needs to borrow really big money, it can either ask a bank for the cash, or it could appeal to bond investors, collectively called the bond market. Either way, the company gets the cash and the lender or lenders get a written agreement. Depending on who the lender is, that piece of paper is called a loan agreement or a bond. But it has the same basic information: it says Company X owes the bearer a certain amount of money (the principle); that the money must be paid back by a certain date (the term); and until then Company X has to pay a certain amount of money to the bearer each month (the interest rate).
It used to be that the biggest distinction between a loan and a bond was that a bond could be traded back and forth after the money was lent out, whereas a loan was held by the bank until it matured. Today, however, loans are also sliced up into little bits and traded between banks and institutions, just like bonds. And the process of arranging bond financing looks a lot like arranging a loan these days: in both cases, the borrowing company has to travel up and down the country on a so-called road show, meeting banks and investors in order to determine how much it can borrow, and how much interest it’ll have to pay.
Paddy Hirsch is Senior Producer of personal finance at Marketplace, and author of the explainer, “Man vs Markets.”
Farrell says we’re entering a new zone of fear because if interst rates start rising, the conversation will shift to what the Fed will do. If people start selling bonds because of an inflection to sell stock, what impact will that have on bond owners?
“So you and I are on seesaw. You’re bond prices, I’m bond yields, the interest rate. As the interest rates go up, you go down. It’s just a mathematical relationship. So the higher interest rates go, the lower bond prices go,” says Farrell. “It means losses for people who own bonds.”
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