Is a yield bubble forming in corporate bonds?

Therefore, not only would flows into corporate bond funds slow, but existing money might leave in search of assets with better inflation protection.

Inflation is often associated with economic growth, and corporate bonds would probably fare better than government bonds under this environment as the yield premium for holding corporate bond risk reduces, offsetting the rise in underlying government bond yields.

The worse-case scenario is if further quantitative easing fails to spark economic growth into life, but still results in inflation as too much money is printed by authorities.

Corporate bonds would then have to deal with higher government yields and a rising corporate bond risk premium.

A balancing act

Falling yields therefore are not currently a problem for the corporate bond market. The risk is that the current trend continues for a number of months, forming a yield bubble that is ultimately burst by significant and unexpected inflation.

Central bankers, particularly in the US and the UK, seem to be very keen on avoiding deflation at all costs, but their attempts increasingly appear to be art rather than science.

In the meantime, bond market bulls are happy to ride yields ever lower and hope they can get out before everyone else if and when the bubble bursts.

Bennett focuses on allocation within the credit funds as well as providing credit input to macro strategies at LGIM. He joined the firm in May 2008, having spent the previous three years at Lehman as a Director within the bank's credit strategy function.