Yesterday, in the FOMC notes, the Federal Reserve made a stark admission: “several expressed concern that an extended period of low interest rates risked intensifying incentives for investors to reach for yield and could lead to the misallocation of capital and mispricing of risk, with possible adverse consequences for financial stability.” To this, Bank of America chief credit strategist Hans Mikkelsen had an amusing retort:
"We agree. However, because we are still in the reach for yield phase we remain bullish on HG corporate bond spreads."
In other words, it's a bubble and everyone - even the Fed - knows it, just as a recent survey also by BofA revealed, but keep on buying because, well, TINA.
But who is buying, and how much?
Answering the latter first, Mikkelsen notes that the HG US corporate bond market has more than doubled in size since the financial crisis. Indeed, as the chart below shows, since the financial crisis the amount of Investment Grade debt has surged from over $2 trillion to just under $6 trillion.
As for the more important question, namely "who bought all this debt", the answer is surprising: mostly domestic retail and foreign investors. Here is BofA:
"that expansion was bought by just two investors – mutual funds/ETF and foreigners (Figure 2).
In the first several years 2010-2013 the Fed-induced declining interest rates and QE drove retail money into bond funds and ETFs. Then increasingly with the help from foreign central banks - in response to global weakness the - foreign investor moved in. As we have documented extensively, this year we are seeing accelerating foreign buying and still meaningful inflows to bond funds/ETF. Of course the stability concerns in our market are centered around the fact that a lot of retail and foreign money does not naturally belong here, and that flows could reverse with a shift in monetary policy. Again, we share those concerns but the “financial instability” phase appears only a very low risk anytime soon – and this is not just under the Fed’s control as foreign central banks play crucial roles. The Fed can end the inflows to bond funds and ETFs if they want to, but will have more difficulties keeping foreign investors out."
Back in the 2006 credit bubble, it was mostly retail investors (who rushed to purchase houses because as Bernanke vowed, housing has never dropped and likely wouldn't) who got slammed, as well as foreign asset managers, who bought up all the CDO, CDO squared, and other toxic acronym nonsense: they were wiped out first. Judging by the even greater credit bubble this time around, one which ironically has been used to fund record buybacks and push the stock market and management bonuses to record highs, it is they who will once again be wiped out just as soon as this next bond bubble bursts. Just keep an eye on this rising rates for the catalyst...