Supply/Demand Imbalance Causing Yields to be Low

A question we have heard a lot from investors over the past year is whyinterest rates are so low when it seems that governments around the world, including our own, are creating massive amounts of debt.  When looking at the increase in federal borrowing, it is reasonable to assume that the market would be awash in debt, but the truth is that demand for high quality bonds has far outstripped supply.  An article in the International Herald Tribune last week focused on the fact that, along with quantitative easing, new regulations to strengthen bank balance sheets and derivatives markets have prompted concerns about a lack of high quality bonds in the marketplace.  JP Morgan estimates that the world’s central banks and commercial banks now hold roughly $24 trillion worth of bonds, or 55% of the entire $44 trillion of government, asset-backed and corporate bonds that are included in the Barclays Multiverse Global Bond Index.  If you only look at the government bond subset of the market, banks and central banks hold more than two-thirds of the investable market.  The lack of bonds available has added to a growing concern about a shortage of high quality bonds to be used as collateral within the financial system to raise cash.  Chairman Bernanke has stated that the Fed is evaluating the effects of quantitative easing to ensure that it is not causing stresses in the market.  So far, there is no indication that the Fed has any plans to change its policy, so we would expect the current supply/demand imbalance to continue into the foreseeable future.