Easing financing terms and the increasing number of corporate debt issues to fund special dividends and share buybacks are two developing trends that could negatively affect bond markets, according to the May Bond Market Observations from Standish, the Boston-based fixed income specialist for BNY Mellon.
"Both trends are detrimental to bond holders," said Thomas D. Higgins, chief economist for Standish. "We are avoiding areas of the bond markets where we believe we are not being compensated for the associated risks."
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Despite these trends, Standish notes in the May report that it does not see evidence of imminent overheating in U.S. fixed income markets, except for Treasuries. The report also notes the benefits of liquidity created by central banks, including the lowered systemic risk and the rallies in global capital markets.
However, the report points to the diminishing effectiveness in generating real economic activity from successive rounds of quantitative easing. "Such policies may have long-term consequences, which could increase financial instability in the future," Higgins said.
Increased liquidity may raise credit risks by compromising bank underwriting standards or discouraging necessary balance sheet repair and deleveraging as has occurred in Europe, according to the report. It also could lead to a yield-seeking behavior by investors that can push asset prices beyond their fundamental values and create bubbles in the financial markets, the report said.
Regarding Treasuries, the Standish report notes that they are probably the most overvalued of all fixed income assets due to the quantitative easing policies of the Federal Reserve. However, this is viewed as a byproduct of the easing policies to support economic activity, according to the report.
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