‘When a man is tired of London, he is tired of life’, so said the English writer Samuel Johnson.  There is no doubt it’s a vibrant City, the great melting pot where nothing remains the same for very long especially within the financial markets. Being a fairly regular visitor for nearly 20 years, there’s not much about London that I don’t know, yet every time I go I learn something new.  Normally it’s a case of spending more time travelling to meetings than actually in the meetings themselves and without realising it you are an integral part of the perpetual motion rate race that you give out about when you return home.

For once as part of a two day course in London, ‘best practice and compliance in financial communications’, I got to sit in the one room for more than two hours without having to think about my next destination.  A course for those that have a depth of knowledge within the financial communications arena, it was intriguing to hear the diversely differing views of the markets, regulation and the future direction of financial communications from those that work across many different sectors within the City.

The spillover of politics, economics and the impact upon the markets was never far away. To reinforce the point, having courted opinion on a case in the bond market that I have been following for some time, I was intrigued to hear a common view that Michael Hastenstab shifted the Irish market last year.  Whatever his impact he is now estimated to own €8.5bn, which is in the region of 10%,  of the Irish bond market but then again that’s just a fraction of the €165 billion of assets under his management.  

Back in 2011 when Hastenstab first started to purchase Irish bonds the yield, which is the rate at which any government must repay investors for bonds, increased to 14% the highest levels since the currency crisis of the 1990’s with Ireland’s credit rating downgraded to junk status.  

From the outside looking in, the financial markets can appear very complex but for Hastenstab, fixed income portfolio manager, at Californian based Franklin Templeton, it was the market’s oversimplification that created his opportunity.  By tarnishing a number of countries with the same brush, Greece, Portugal, Italy and Ireland the markets according to Hastenstab were oversimplifying the situation.  Whilst acknowledging the social cost of the financial crisis, he saw labour flexibility, an adjustment in real wages enabling exports to become more competitive and dealing with its problems up front, including recapitalisation of its banks, as differentiating Ireland from the likes of Greece.  Hastenstab’s punt in Ireland has so far reaped rewards with Irish sovereign bonds maturing in 2020, rising in price by around 22% during the 12 months to December 31st 2012, according to the Irish Stock Exchange with yields now down to 3.7%.

Of course, the stakes for Ireland is very high indeed as its sovereign debt is inextricably linked with its bid to become the first nation to leave the bailout programme since the debt crisis started more than three years ago. It was reported that Ireland took a step towards exiting its bailout programme in March by selling €5bn worth of 10 year bonds, passing a major test of its ability to raise long-term funds from capital markets.  The yields demanded on these 10 year Irish bonds were 4.15% a significant premium over what Germany pays at 1.48%, highlighting the gulf that exists between two Countries economically bound by the Eurozone.  The announcement earlier this month that EU Finance Ministers have allowed Ireland seven more years to pay back its bailout loans, which some see as payment for good behaviour, has been followed up by calls for an improvement in the Country’s credit rating by Finance Minister Michael Noonan and others.   Media speculation yesterday stated that high level sources in the Irish government have committed to a significant package included in the next budget to recognise the sacrifices middle-class taxpayers have endured over the past five years as part of a strategy to demonstrate the era of austerity is drawing to a close.  Time will tell.

So what about the future for bonds and the bond markets? Bonds of course be they corporate or government, are seen as being safer than shares because they pay a fixed, regular income and investors get their money back when the bonds mature.    They have also delivered higher total returns than shares for more than 20 years.

However, Fitch the credit rating agency, which last week downgraded the UK to AA+, capping off a tough week for the Chancellor (following the downgrading of the UK’s growth forecast by the IMF) is one of a number of organisations voicing concerns regarding an impending  ‘bond bubble’.

With historically low interest rates, instigated by the UK and other federal governments to support economic growth, there has been a knock-on effect on government bonds.  At interest rates of 0.5%, the fixed rate of interest paid by the gilts or UK government bonds has become correspondingly more valuable and their prices have risen.  When bond prices rise, the yield falls, so anyone buying bonds now will often get very small returns.

Purchases in these gilts have increased with investors attracted to their security during the financial challenges within the Eurozone.  These valuations have been further boosted by quantitative easing, which has seen the Bank of England purchase huge quantities of government bonds.  The overvaluation of these bonds means that there is a risk of a sharp correction if the economic outlook improves although central banks appear determined to keep interest rates low and negative in real terms.

A return of interest rates and bond yields to their historic trading range however, whilst a clear sign of a global economic normality, could mean choppy waters ahead for the bond markets with some commentators stating that bondholders could lose up to 40pc of their money.  Who’d suffer?

One such group that is believed to be exposed is those approaching retirement age.  The increase in demand for bonds and gilts in recent years whilst pushing prices up, and yields down, partly explains why annuity rates have tumbled, as they depend on gilt yields.

Whilst many pension savers may have chosen to invest in bond funds many more may find their pension funds automatically switched away from shares and into bonds as they get older. Known as ‘lifestyling’ and designed to protect portfolios from significant stock market swings due to bond prices being historically less volatile than shares. Company pension schemes have tended to adopt the practice, as do many personal pension plans.   There are steps that can be taken to safeguard against this but as with any bubble or crash, it’s a matter of timing.  If the bond bubble bursts nobody knows exactly when it will be with the result that there will always be casualties.

Shane Finnegan is Client Director at Public Affairs and Public Relations agency, Aiken PR.