Macroscope | The ‘hunt for yield’ is getting way out of hand

Alan Greenspan, the former chairman of the Federal Reserve, is not ideally placed to opine on the threat posed by asset bubbles in financial markets. This is, after all, the central banker who is widely blamed for having sewn the seeds of the 2008 global financial crisis by refusing to prick the US housing bubble which triggered the crash.

Yet Greenspan’s words still carry a lot of weight with market commentators and investors. So when he warned in an interview on Tuesday that “we are experiencing a bubble, not in stock prices, but in bond prices” which “is not discounted in the marketplace”, it received a lot of attention.

While there is intense debate, as I explained in an earlier column, about how debt markets will fare once other leading central banks – in particular the European Central Bank – join the Fed in withdrawing monetary stimulus, the fierceness of the decline in bond yields stemming from international investors’ voracious appetite for higher-yielding assets is indisputable.

The “hunt for yield”, which has intensified since the yields on a large portion of the stock of government debt in Europe and Japan turned negative due to aggressive programmes of quantitative easing, has become one of the most conspicuous trends in markets over the past several years, and one that is setting off alarm bells.

According to data from Morningstar, investors poured a staggering US$355 billion into bond funds in the first five months of this year – compared with US$375bn in the whole of 2016 – despite mounting concerns that debt markets are vulnerable to central bank missteps, with a bond market crash cited as the biggest “tail risk” in the latest fund manager survey by Bank of America Merrill Lynch. Moreover, a significant portion of this money was directed to funds investing in US and emerging market debt.

Spreads, or the risk premium, on investment-grade US corporate bonds have narrowed to their lowest, or tightest, levels since mid-2014 and, more worryingly, are now only some 10 to 15 basis points higher than their historical lows, according to data from JPMorgan. The plunge in the dollar this year has increased the appeal of dollar-denominated assets, with foreign investors purchasing US$26bn of US corporate bonds in May, the largest monthly inflow since 2009, according to the Financial Times.