Fears of a bubble in the bond market may be misplaced,
according to new research from the Federal Reserve Board.
In a paper this month, senior economist Yoshio Nozawa made a
case against frothy corporate bond markets,
arguing that any mispricing in the asset class is
If there is froth it the corporate bond market, then
long-run bond risk premiums would be too low relative to the
[stock market] benchmark during the period with credit
expansion, he wrote. There is little evidence that
the bond risk premiums are too low prior to
The findings come after multiple warnings from analysts and
asset managers over the last year that a sustained period of
low interest rates has created a bubble in the bond market.
Less than a month ago, former Fed chair Alan Greenspan said in
an interview with Bloomberg that investors are
experiencing a bubble, not in stock prices but in bond
Nozawas research put this theory to the test. Looking
at credit spreads and bond price data relative to cash flows
and risk premiums, he sought to determine whether variation in
spreads between 1973 and 2014 was due to overly optimistic
investors providing too much credit to borrowers, or overly
pessimistic fund managers providing too little.
Although risk premiums for corporate bonds did fluctuate
with market cycles, falling low during booms and rising during
recessions, Nozawa found that narrow credit spreads during
booms reflect lower market risk exposure, implying there
is no evidence for pronounced mispricing then.
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Even high-yield bonds, which come with higher risk and can
be more difficult to trade in downturns, displayed no strong
evidence of mispricing, according to Nozawa.
It seems premature to conclude that low credit spreads
prior to recessions are solely due to the mispricing of bonds
caused by the over-supply of credit, he said.