Interest rates Aug10.pngHigh quality 3 year government bond yields are now less than 1%, as shown in the above chart from of the US Treasury market. US rates have not been this low since the 1940’s and 1950’s.
This has also led to a major rally in corporate bonds, based on increasing fears of a double-dip recession. Investors prefer the added security of corporate bonds, which appear ‘safer’ than ordinary shares. Pension funds are also attracted by the higher yields, relative to high quality government bonds.
However, potential investors should be careful. The blog understands that fees are relatively low for this type of work, so the banks need to generate high volume to compensate. They are achieving this by segmenting the market:
• Higher quality bonds (those with a strong position in the event of bankruptcy) are being sold to ‘sophisticated investors’ who undertake their own research.
• Lower quality product is being sold to other investors, who don’t ask awkward questions about repayment, and just focus on the yield.
No doubt some bonds will end-up being under-priced in the stampede. But high quality companies are generally taking full advantage of the opportunity to reduce their financing costs. This month, for example, IBM sold $1.5bn of 3 year bonds at a yield of just 1%.
Caveat emptor (“buyer beware”) is probably a good motto when considering an investment in this area.