Three myths about the bond market
The era of declining interest rates may have come to an end, and many investors don't
The article discusses three myths about the bond market:
1. Safe Bonds Are Risk-Free Bonds: The article explains that even bonds with a low probability of default, like US Treasury bonds, are not entirely risk-free. Longer-term bonds can experience greater price volatility when interest rates change, making them not truly riskless. Even short-term bonds, like three-month Treasury bills, are not entirely riskless, as they can expose investors to inflation risk or varying interest rates.
2. Federal Reserve Policy Determines Long-Term Interest Rates: It challenges the myth that the Federal Reserve's short-term rate decisions significantly influence longer-term interest rates. While there might be some short-term impact around Fed announcements, the article argues that macroeconomic factors, supply and demand for bonds, debt levels, inflation expectations, and term premiums have a more significant influence on long-term rates.
3. An Ageing Population Means Future Bond Yields Will Be Lower: Contrary to the belief that bond yields fall as the population ages, the article suggests that this relationship is not straightforward. It points out that many developed countries with aging populations also have large underfunded entitlements and will need to issue more debt. As older households in the US do not buy debt as extensively as in Japan, the aging population might lead to an increase in bond rates rather than a decrease.
Overall, the article suggests that the bond market may be entering a period of higher interest rates and increased volatility, challenging the notion that bonds are always a safe and stable investment.
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