Knowing the Dangers of Bubbling Bond Market

bond market

The real condition of the bond market (Anleihemarkt) does not match the theory of bubble. Interest rates are close to historical highs, and there is a controversial debate about why. Some people believe that the costs are low because governments and global central banks drive the entire global market. Others convince us that the prices are low because we are on the threshold of bad situations from depression or recession. However, it will probably be so awful that forward-thinking investors will be very happy to keep the last interest rates for a very long time. 

Government intervention has created distortions in the bond market. That is why it has brought interest rates down. From mortgage loan rates to bond yields to bank account interest rates, interest rates continue to fall. At this moment, it is impossible to say whether they are justified, but it is obvious that investors are talking about their concerns. The last decade has scared many investors and equity investors and sent them looking for safer investments. The numbers are staggering. So everyone is buying bonds, and no one seems particularly worried about the price.

bond market

Reasons for Bubble Bond Market Is Not Working

The basis of the bubbles in the investment world goes back centuries. Unfortunately, people seem to be well connected, and it is quite difficult for any of us to challenge the moving investments. From the Dutch tulips of the 1600s to the technology stocks of the 1990s to the new land bubble, investors are always looking for the great things to come. These bubbles follow the same path: prices rise to unsustainable levels, without any inherent logic or connection to valuation’s fundamental principles. Investors, along with fraudsters, throw away huge amounts of money and are punished.

The bond market is not in a bubble because traders can keep their bonds until adulthood. Assuming that their bonds are not in default, shareholders will receive back 100% of their capital. Also, we do not visit speculative securities, as we have seen in several bubbles. The situation will not be a replica of the technical inventory or real estate bubbles.

Potential Losses for Bond Investors

bond marketIf interest rates go up, bond prices will go down. It is an excellent example of how interest rate risk works. Long bonds tend to offer higher returns because investors have to wait longer to get their capital back. If interest rates rise by one percentage point, the two bonds immediately lose some of their value. The one-year bond will probably lose about 1% of its value. In response to the decline in specific values, the investor may choose to hold the bond until maturity at the end of the year. You will get your principal back with a return of 1%.

But the 30-year bond will likely continue to lose value as it matures. Instead of 1%, the security could lose about 16% of its value. Meanwhile, it is a bond worth 84 cents for every dollar returned, and if you want to advertise your bond to pay your current expenses, you will have no choice but to understand the reduction.

Let’s take the two specific bonds we used in our last case and suppose that interest rates rise by five percentage points. The one-year bond will lose about 5% of its value. Again, the investor has to wait one year at a time, and they will get their head and a return of 1%. The 30-year bond will lose about 54% of its value, and bonds should be a safe investment. Only bond investors can suffer losses in this circumstance, while entrepreneurs, customers, and current investors will be better off.