Bond buyers shrug off poor yields

Global bond prices are at record levels, yields in some countries have turned negative and analysts are questioning how much longer all of this can continue. Yet investors are still buying bonds.

A recent report by J.P. Morgan predicts bond demand will likely outstrip global supply by US$450 billion this year, topping last year’s level of US$384 billion, even though the market is anticipating an interest rate hike from the U.S. Federal Reserve later this year.

Why are investors willing to buy into negative yields and the prospect of losing on their returns? Because they can’t afford not to, say analysts.

“The global narrative remains maximum liquidity and minimal interest rates,” said Michael Hartnett, chief investment strategist at Bank of America-Merrill Lynch. “And it’s impossible to be max bearish with such an extravagant monetary backdrop.”

The flood into bonds was apparent again Monday after Belgium became the sixth eurozone country to sell its five-year bonds at a negative yield.

The five-year notes were sold with an average yield of -0.056 per cent.

Mark Schofield, economist at Citigroup, said he does not see the continued appetite for European bonds dissipating anytime soon.

“So long as the ECB continues to deplete the pool of available debt, forcing itself further along the curve, extending duration, investors have no choice but to do the same, or risk underperforming the index,” he said.

The biggest trend in the market, Schofield said, is that investors no longer care about bond yields. Instead, investors are looking to hold bonds for their duration, with shorter-term bonds being viewed as particularly attractive because of their potential for price growth.

“In the past, investors bought bonds for income and stocks for growth, but for almost three years now, investors have been buying equities for income … and that leaves them exposed to a downturn in growth,” he said. “The hedge to that risk is to be long duration.”

Bonds were one of the best-performing asset classes last year globally and investor demand reflected that. J.P. Morgan notes in its report that retail investors poured US$500 billion into U.S. bond funds last year.

In the fourth quarter, flows into fixed-income mutual funds edged out stock funds for the third straight quarter. The hunger for bonds remains even though fund managers acknowledge the space is at historic price levels. A net 84 per cent of managers surveyed by the Bank of America-Merrill Lynch earlier this month said they believe bonds are overvalued, the highest percentage ever recorded in the survey. But managers were also bearish on bonds last year and ended up being wrong, as fixed-income posted returns that were among the best of any asset class.

Even though many see little room for yields to go lower, Schofield said it is unlikely investors will turn bearish if central banks continue to ease and the global economy remains weak.

“Yield is irrelevant in the current environment,” he said. “Investors are not trading yield, they are trading duration.”