Tensions over bond market liquidity rise

Ultra-loose monetary policies pursued by Central banks have pushed the bond yields to record low. Swiss government bond yields are trading in negative territory, German yields are negative up to six years. Stories are similar for Finland, France, and Ireland. Yields in UK, US are off negative territory but still at very low.

• However, numbers of investors are warning against overvaluation and disorderly selloffs. According to FT and CFA UK, 80% of the global fund managers said that bonds are overvalued and govt. bonds to be most overvalued.

Two major concerns are -

• Massive bond buying by the central banks have cornered the bond market which reduced liquidity and moreover fuelled a massive bond buying spree. Risks are not symmetric but high yield bonds are also enjoying record low yields. A disorderly bust of the bond bubble could be severe.
  
  
• Liquidity is of most concern. Volcker
  rules have banned investment banks to trade in their own account but up to a certain limit. Before the rules these banks used to hold large portions of inventories which were used to provide liquidity.

Since the easing cycle, fund managers across globe loaded their portfolio with bonds mainly to benefit from capital appreciation, however trading volumes have not expanded much. At any adverse point, massive selling spree could result in messy unwinding.

Biggest threat for the bond market is sudden return of inflation. With bond yields at record low, it is advisable to hold equities for better long term return unless you are concerned over capital fluctuations.