Bond Bears

I've held off from the temptation to buy corporate bond funds, despite the appealing 7-9% yields and recommendations from people whose recommendations I normally trust, like Mark Dampier at Hargreaves Lansdown.

Now I tend to be a bit ahead of the market in my timing. So it was that I lost my money when in 2005 I made a bet against house prices, in the shape of a covered warrant. So it was that I had to sit through six months of inactivity when I called the bottom of the tech market just a tad early. Yet again, I'm sitting watching other people make money...

My worry is that UK bond funds look good right now, with low inflation and low interest rates. But can low interest rates last?

Let me state the bear case briefly.

• Low sterling has reduced the euro value of our money. So far the press has talked incessantly about how European holidays will cost more. They're missing the real elephant in the room - imports from Europe. French Golden Delicious, Dutch tomatoes, German software will all cost more. That puts pressure on inflation. (Incidentally I'm amazed how inflation is continuing to hold up despite the fact that mortgage costs have fallen dramatically and energy prices are headed downwards. There is some real cost pressure there already, and the sterling impact hasn't been felt yet.) We are importing inflation. Not a good thing to be doing.
  
• Increased government borrowing requirement will lead to increased gilts issuance as well as a perception of higher risk. If the government wants to fund more, riskier debt, it's going to have to increase the amount it's willing to pay for it - in other words, it will have to pay a higher interest rate. That's the case in the US as well. Most of the arguments I've seen for buying corporate bond funds focus on the spread between government debt and corporates. But the bulls' assumption is that corporate rates will come down (and consequently the price of the bonds will rise). I fear it's more likely that government rates will rise.

Now I started thinking this about November last year. And now, at the beginning of February, I'm beginning to see a few fund managers crawling out of the woodwork with the same ideas. Intriguing.