It has become almost accepted wisdom that “there is a bubble in the bond market”. But which bond market? I would say that lending money to the UK government for ten years in return for less than 2 per cent is a pretty lousy trade, but I’m not sure it’s a bubble. There isn’t going to be a “99 per cent” club for gilts as there was for dotcom stocks. You could say the same for many investment-grade corporate bonds.

Talk of a bubble in high yield is closer to the mark. Pundits have vied with each other to provide ever more shocking examples of frontier markets that can borrow for 10 years at sub-5 per cent yields: Bolivia and Rwanda are just two of the more recent. That may indeed be a bubble. Still, I doubt many UK investors are lying awake at night worrying about Bolivian government debt blowing a hole in their pensions.

Advisers have been badgering me for weeks about the London Stock Exchange’s order book for retail bonds (Orb), which allows individual investors to buy bonds in small denominations on a regulated market.

Credit quality isn’t what it was in the market’s early days, they grumble, when big banks and retailers were the main issuers. Many of the companies raising money there now are not even scored by credit rating agencies and some of the covenants are weak. They say retail investors, unversed in the finer technicalities of fixed income, are treating these as savings products and buying indiscriminately. Sooner or later, there’ll be a default and savers will realise these are not deposits and they’re not covered by the Financial Services Compensation Scheme. There’ll be tears at bedtime.

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It’s easy to dismiss such complaints as the diatribes of the disintermediated; advisers can’t stand it that investors are going direct, rather than taking their expensive advice and buying bond funds. But they have a point. A properly structured bond portfolio should resemble a “ladder” of maturities, with holdings spread across different sectors. But the stock selection process in this market, where each new issue is enthusiastically marketed by a cohort of retail stock brokers, is most likely: “Six per cent? I’ll have a bit of that thank you very much!”

The bonds listed on Orb have three big redeeming features, though. One is that in the main, you can put them into Isas (there must be five years or more to maturity at the point of purchase). Another is that you can get rid of them.

Granted, secondary market liquidity is pretty thin and the market has not been tested by a serious company crisis. But there is at least two-way pricing and you can sell anytime you want. Finally, companies have to adhere to a bit of due process before they can list. Because the securities are tradeable, issuers must submit a prospectus that conforms to the Prospectus Directive and is vetted by the UK Listing Authority.

I’m inherently mistrustful of any investment that doesn’t allow me to change my mind

– Jonathan Eley

That’s all in contrast to the so-called “mini-bond” market. These popular retail bonds are offered in small amounts direct to consumers by companies as diverse as John Lewis and King of Shaves. Capita, which acts as administrator for many of them, said this week that the market for these could be worth £1bn by the end of 2013 and £8bn by the end of 2017. A £15m mini-bond issue for the Jockey Club, widely advertised on London’s Tube network, closes this week – just in time for another, for health charity Nuffield, to open.

There is no secondary market in mini-bonds – investors are locked in for the duration of the loan. Because I’m prone to self-doubt and indecision, I’m inherently mistrustful of any investment that doesn’t allow me to change my mind. There is also little regulation of the issue process. There is no prospectus, just an offer document, and as a “financial promotion” it must only be “fair and not misleading” in the eyes of the (regulated) company promoting it. The potential for misunderstandings is fairly obvious. There has already been a failure in this market, albeit a small one: alternative lending company Frodo has gone into administration, and the interest on a £750,000 mini-bond is being paid from the capital raised while the administrator seeks a buyer.

None of this would matter too much if investors were being lavishly rewarded for the risks they are taking. But it’s hard to say they are. The Jockey Club issue trumpets a headline rate of 7.75 per cent, but 3 percentage points of this comes in the form of racing-related freebies, rather like the sports debentures of old. John Lewis pays part of its coupon in store vouchers. And after-tax interest rates will be lower still for many savers.

So there you have it – interest rates of 4 to 6 per cent for investments that aren’t regulated, aren’t part of the compensation scheme, can’t be placed in Isas and which you can’t sell or transfer to anyone else. If you’re looking for “the bond bubble”, I think I might have found it.

jonathan.eley@ft.com

The equity market rally is putting a disciplined investment approach to the test.

The adage “don’t chase a rally” is a core principle of investing, but such advice counts for little at the moment. As equities advance further into record territory, the S&P 500 this year has already risen nearly 17 per cent.

After spending much of April unable to break through 1,600, the S&P has mainly been a one-way bet in May, rising towards 1,670 this week.

This is an equity market that rallies most trading days and shrugs aside disappointing economic news with limited price corrections. A case in point was the modest pullback on Thursday after a series of weak data, led by monthly inflation easing the most in four years. That pullback was yet another blip as the market closed at a record high on Friday.

The performance of equities is truly eye opening, and it’s a rally being fuelled by the Federal Reserve’s easy money policy of quantitative easing, all the while downplaying the fundamental and technical basics that ultimately must underpin financial markets.

An uneven recovery in the economy and modest sales growth at the corporate level are being brushed aside for now by the power of central bank liquidity. The equity rally has also occurred without significant fund flows into the market that would confirm investors are back in a big way, let alone justify the big rise in prices since January.

All of which places both private and professional investors in a quandary, particularly for those that have missed the rally so far and have spare cash earning next to nothing.

At this juncture do you chase the rally and place your faith in not fighting the central bank? For history buffs, the S&P is currently tracking very closely its performance from 1995, a year when the benchmark ultimately rose 34 per cent.

Or as an investor do you hold fast and refuse to jump into a market that has risen more than 20 per cent from its low of last November without a significant correction?

Investors, whose portfolios are lagging behind the S&P and possibly face the loss of clients, may throw in the towel and help drive equity prices higher in the coming weeks.

A common refrain of late among investors has been to rue not stepping into a market that back in February briefly dropped 2.8 per cent below 1,500 and then eased 3.3 per cent over several days in mid-April below 1,550, before moving onwards and upwards.

The gnawing fear now is that waiting for a sizeable equity correction against the backdrop of QE3 is a forlorn hope. Investors, whose portfolios are lagging behind the S&P and possibly face the loss of clients, may throw in the towel and help drive equity prices higher in the coming weeks.

This is how momentum trades, as seen with Apple and gold in recent years, really get going, as the fear of losing money is eclipsed by the greed of missing out.

But the Fed’s open-ended suppression of interest rates does trouble some notable equity bulls.

This week, David Tepper, the hedge fund manager who back in September 2010 was stridently bullish on equities as the Fed unleashed QE2, told CNBC that the rally still had legs, but he also issued a warning that the market was in danger of overheating unless the central bank pared its support.

“There better be a true taper, or else you’re back to the second half of ’99,” he said citing the planned additional $500bn in Fed purchases against net debt issuance by the Treasury of $100bn by the end of the year. For Mr Tepper, that $400bn difference could flow into stocks and repeat the last vestiges of the equity bubble in 1999.

“It’s a backwards argument,” he said. “To keep the markets going up at a steady pace the Fed has to taper back.”

The problem with stepping back from the QE pedal is that it would focus attention on a sub-par performance for the economy that is hardly growing at a pace to justify the current equity market rally. Ultimately, easy money is the driver of the equity rally, and for investors contemplating their next move it really all comes down to the Fed.

In the current momentum driven market we are on the cusp of partying like its 1999, all the while flirting with the danger that when the music stops the consequences of having bought anywhere near the top are likely to be brutal and swift.

michael.mackenzie@ft.com

High-quality companies have been good investments since the 2008 crisis. Many investors bought their shares, or added to existing holdings. So did I. And, increasingly, so has everyone else, with the result that prices have risen to the point where we need to ask whether “quality” is now overvalued and – not necessarily the same – when will its strong performance falter?

To put this in context, a few days ago a respected investment house described as “bonkers” the current valuation of UK consumer staples stocks such as Diageo and Unilever.

Others have pointed out that the $5bn offered by Unilever to buy a further 22 per cent of its partly-owned Indian subsidiary Hindustan Unilever was pitched at a valuation of 36 times HUL’s earnings. At first glance, 36 times earnings does look pretty bonkers. Has Unilever been caught up in an irrational enthusiasm for emerging markets? And should Diageo’s shares really be trading at 20 times historic earnings?

Any discussion of these issues has to begin with an acknowledgment of the fundamental investment attractions of these shares – which are self-evidently great. I would contend that more investment weight should be placed on the excellence of a business than its valuation.

It is easier to be certain that Diageo is a great business than it is to decide whether or not it is overpriced on 20 times earnings, or still cheap on 15 times. The excellence is not debatable; the valuation discussion is worryingly arbitrary. So, I tend not to worry about valuation unless truly egregious levels are struck – say a price/earnings ratio of 30 times or more.

To understand why, look at the inverse of price-earnings, which is earnings yield. To paraphrase Ken Fisher, “the p/e of 20 times scares you, the earnings yield of 5 per cent looks attractive”. Of course a p/e of 20 times and earnings yield of 5 per cent are one and the same. Why would anyone, especially at current interest rates, not covet a 5 per cent inflation-protected return from a wonderful corporation? On this argument, even an earnings yield of 3 per cent (a p/e of 33 times) doesn’t look bad compared to the paltry returns on cash and bonds.

Even if I were smart or lucky enough to foresee a coming change in the investment weather, I would not act upon it

– Nick Train

But “quality” consumer staples are not simply proxies for government bonds whose valuations should accordingly rise and fall with the gilt market. That would be the case, arguably, for utility shares. But the best consumer stocks are true growth companies, with the biggest growth opportunity in their history opening up for them in the early decades of the 21st century.

This is the context against which to consider Unilever’s move to top up its HUL holding. Yes, HUL stock is up 16-fold since 1993, but most analysts accept the Indian consumer story is still only just starting. I’d guess that even on 36 times earnings Unilever is getting a bargain.

So, my answer to the first question is no, “quality” companies with a credible growth opportunity are not yet overvalued. But that doesn’t mean their outperformance is destined to continue indefinitely. What will bring it to a halt is a shift in investors’ appetite for lower quality companies. These could be “cyclical” or “speculative”. During such episodes as we experienced in 2007, when mining outperformed and eclipsed other sectors, or 1999/2000 (the tech boom), even the highest quality companies can suffer extended periods of poor returns. There will certainly be another, of whatever stripe, and my kind of stocks will certainly perform less well through it.

But even if I were smart or lucky enough to foresee a coming change in the investment weather, which meant lower quality was likely to outperform for a period, I would not act upon it. My conviction is that investment in high-quality companies is a winning strategy. But for that strategy to work, one has to stick with it.

Nick Train is investment manager of the Finsbury Growth & Income Trust

The recent sharp rise in Japanese government bond yields has set alarm bells ringing, given the aggressive policy easing undertaken by the Bank of Japan. But should global bond markets treat it as a wake-up call – or take it with a pinch of salt?

Kit Juckes, strategist at Société Générale, says it is tempting to ask if the markets should really care.

“JGB yields don’t correlate terribly well with the Nikkei, the yen, or anything else for that matter,” he says. “So given that yields are low in absolute terms, and low relative to the Bank of Japan’s inflation target – and that the weekly jump in yields is, in absolute terms, only a little larger than in Treasuries – you could pretty quickly dismiss the whole move as irrelevant.

“But it is still the biggest absolute move in a week since 2006. So the question is whether this is a storm in a teacup or a canary in a coal mine? Will Japanese investors switch back from equities to bonds? Will capital outflows reverse?

“For now, I am more confident of further yen weakness than of the idea that yen weakness will drive global risk markets ever higher.”

Michael Taylor at Lombard Street Research says higher Japanese interest rates need not necessarily be a disaster.

“Higher rates would mean one of two things,” he says. “In the right circumstances it would mark a normalisation of economic conditions with the return of positive inflation and an upward trend in nominal GDP, helping to reduce the public deficit and debt ratios.

“But if JGB yields spike up because of fears over debt sustainability should ‘Abenomics’ be perceived as failing – ie growth stalling and deflation persisting or returning – then it would greatly exacerbate the already dire state of Japan’s public finances and could trigger a sovereign debt crisis.

“A rise in interest rates would be good for Japan’s household sector – at least in one respect. Japanese households are net recipients of interest income – in most other developed economies the household sector is a net payer of interest. So higher rates would boost households’ nominal incomes.”

Divyang Shah, global strategist at IFR Markets, makes the point that what is bad for JGBs is good for eurozone government bonds.

“These are early days for the BoJ’s quantitative easing, and it is likely that the JGB market will eventually settle down,” he says. “But what will the impact be on foreign bond markets and risk markets in general?

“Remember that on the day following the April 4 BoJ meeting, when governor [Haruhiko] Kuroda delivered his policy ‘bazooka’, we saw a massive move lower on core/semi-core bond yields. That move was based on expectations and the flow data is now showing that we have been seeing actual demand.

“This might go some way to explaining why peripheral debt has been rallying at the same time as core markets. The flow data from Japan is likely to remain volatile but supports the argument of staying long core, semi-core and peripheral eurozone debt – except for Slovenia.”

A key market measure of inflation expectations has plumbed its lowest level since August, piling the pressure on many bond investors who flocked to securities linked to rising consumer prices.

Expectations for inflation over the next decade dropped to 2.24 per cent and this measure derived from the difference between inflation-protected bonds and regular Treasury debt has eased from a peak of 2.60 per cent in March.

The move reflects evidence that US consumer prices are moderating with the release of April consumer price data on Thursday affirming that trend.

The easing of inflation pressures leaves the market for Treasury Inflation Protected Securities looking expensive and is set to increase the pressure on investors who in recent years bought insurance against the risk of higher consumer prices in the future.

So far this year, the total return for Tips has been a loss of 1.6 per cent according to a Barclays index while outflows from mutual funds and exchange-traded funds has been hefty.

Investors have pulled $5.3bn from Tips funds after strong inflows since the end of 2006, the last negative year of performance for the asset class.

While lower inflation readings tend to hurt shorter dated Tips, the ease in 10-year expectations suggests that investors believe the cost of long-term insurance is too expensive in the current climate.

Against the backdrop of the Federal Reserve undertaking several rounds of quantitative easing, Wall Street banks have pushed Tips as insurance for investors seeking protection for their Treasury portfolios from the risk of higher inflation.

Jeffrey Gundlach, head of the $60bn bond manager Doubleline, this week told Reuters: “Anything that is an inflation play is a dead money play, just as Tips are dead money.”

Bill Gross last month told the Financial Times that the sell-off for inflation linked securities is “reflecting what might be happening in the real economy and in the nominal economy, in which inflation and real growth has not been successfully stimulated by quantitative easing policies of central banks”.

For some analysts, such as Mike Pond, head of global inflation-linked research at Barclays, the demise of inflation hedging calls are premature.

The bank recommends clients increase some exposure to longer-dated Tips in their portfolios in part as response to a recent rise in US benchmark Treasury yields.

Adrian Miller, director for fixed income at GMP Securities said: “Just because inflation is not a problem now, it surely will be over the longer term.”

The easing of inflation pressures is seen by some in the bond market as forestalling the Federal Reserve reducing its current policy of QE.

The yield on 10-year nominal Treasuries was 7 basis points lower at 1.87 per cent on Thursday.

“The trend in inflation is more than tame enough to help the case for those at the Fed arguing for no let-up in easing, although we still think improvement in the labour market will be the main driver of the decision on when to start scaling down QE,” said Jim O’Sullivan, chief economist at High Frequency Economics.

Are the markets going mad? That is a question many investors might have asked in recent weeks, as stocks in the UK, eurozone and US have soared – even as bond spreads decline.

But, if you want another sign of how peculiar market patterns now seem, take a look at a report recently compiled by Matt King, an analyst at Citigroup. For what is most striking about the current market trends, Mr King argues, is not simply those dazzling equity and bond prices; instead the really notable issue is how many long-standing data patterns have broken down*.

Take a look at the link between unemployment and equity markets. Between 1997 and 2011 the level of unemployment in the eurozone was always inversely correlated to the Stoxx index. However, since 2011 the eurozone jobless rate has jumped from 10 to 12 per cent – even as the Stoxx has risen 10 per cent.

Corporate earnings are another case in point. In recent decades, US earnings revisions have tracked swings in the stock market. But since the start of 2012 there have been net downward earnings revisions – while US stocks have soared. So too with credit spreads and leverage rates. In the past two decades, spreads on investment grade companies have always widened when corporate debt levels rose. But since 2011 the leverage ratio of eurozone companies has risen from 1.4 times to 1.7 times, while spreads have declined from around 210 basis points towards 120bp. A similar pattern is at work in the US.

It is the same story for market measures of economic uncertainty, drawn from business surveys. Indices of uncertainty used to track credit spreads. But while uncertainty has (unsurprisingly) remained elevated since 2011, spreads have tumbled. Or to put it another way, the behaviour of credit and equity markets has moved the opposite direction from fundamentals – on multiple data points.

It is easy to identify the reason for this: as this data has gone haywire in the past couple of years, western central banks have been unleashing an estimated $7tn worth of quantitative easing. This has lowered interest rates on government bonds, forcing investors to search elsewhere for yield. But what has intensified the crunch is that, while central banks have been gobbling up bonds, the supply of assets has declined.

Citi calculates, for example, that net issuance in the US fixed income markets has tumbled from around $2tn in 2007 and $1.5tn in 2010, to a mere $250bn in 2012. Little wonder, then, that spreads have been tightening and investors grabbing at equities; in macro-market terms this is tantamount to a giant, two-pronged squeeze.

However the crucial question now is just how much longer these bizarre conditions can continue. Right now the betting among most analysts I have recently spoken with in London and New York is that these distorted conditions will remain in place far longer than most people expect. The markets apparently agree: measures of volatility are currently running at very low levels, suggesting continued calm.

But while that bet of continued peace is probably correct – particularly given that central banks seem unlikely to abandon QE any time soon – there is an important caveat.

Back in 2007, Mr King sometimes used the image of “a ball in a bowl” to explain how markets behaved during the credit bubble. Between 2001 and 2007 there was such a huge volume of liquidity in the system that markets seemed able to weather small(ish) shocks; just as a ball will roll back into the centre of a bowl if gently shaken, the financial system rebounded quickly from blows like the 2005 downgrade of General Motors.

However, this calm was fragile: beneath the surface there lurked profound contradictions and tensions. Thus when a big shock hit in 2007, the markets hit a tipping point and collapsed – just as a ball will fall out of a bowl, not roll back, if shaken violently.

Mr King suspects that metaphor is an apt description of markets now, and I agree. For while the flood of central bank liquidity is enabling the system to absorb small shocks, it is also masking a host of internal contradictions and fragilities that could surface if a shock hits. Or, to echo a point often made by Nassim Taleb, precisely because central banks are trying to pursue stability at all costs, the potential for a future violent instability is rising apace; “tail risk”, as statisticians say, is growing.

That does not mean a shock will necessarily occur soon; this phoney peace may last months, if not years. But as those equity markets soar, investors would do well to ponder on the data dislocations. Nobody can afford to feel complacent, least of all if they sit in a western finance ministry – or central bank.

*Mind the gap; investing in repressed markets, Citigroup

gillian.tett@ft.com

Billionaire investor Warren Buffett suffered a rare blow on Thursday after Standard & Poor’s cut his investment vehicle’s credit rating, citing an over reliance on its insurance business and raising questions over his succession plans.

The one notch cut to AA of Berkshire Hathaway by the rating agency reflects the unusual record and structure of the Sage of Omaha’s $277bn candy-to-cargo-train collection of businesses built around an insurance company.

S&P reaffirmed the underlying strength of Berkshire’s financial stability – the conglomerate has a $49bn cash pile – but said this was offset in part by the chairman’s preference for large stock holdings in a small number of companies, making its capital base more volatile than peers. The credit rating agency added that “management succession at [Berkshire] is also an offsetting factor”.

Eric Hedman, of S&P’s insurance ratings, told the Financial Times that “what that means is that they have a very unique individual, Warren Buffett, who continues to run the company”.

Mr Buffett said this month that his board had identified his successor, and that little would change at Berkshire after his death, but they had chosen not to make it public. His chairman and chief executive roles will be split, with Mr Buffett’s son serving as non-executive chairman to safeguard the corporate culture.

The rating agency also cited the large contribution to earnings of Burlington Northern Santa Fe, Berkshire’s railroad business, as a long-term risk factor.

The downgrade was technical, after S&P changed the way it analyses insurance companies this month. Adjustments to the Berkshire rating came earlier than for peers because it recently conducted a small bond offering.

Berkshire was unique in that its holding company held the same credit rating as its subsidiaries. S&P said that there would typically be a “three notch” difference to reflect the weaker claim on the underlying businesses. The downgrade by one notch reflected its superior performance relative to other insurers.

Mr Buffett, whose conglomerate owns a stake in S&P rival Moody’s has criticised S&P in the past. In August 2011, when the credit rating agency downgraded the US’s sovereign debt rating, he said it “doesn’t make sense”. A few days later S&P reduced its outlook on Berkshire Hathaway from “stable” to “negative”, along with 10 other insurers, as a result of the US downgrade.

Berkshire A shares were down 0.6 per cent by lunchtime in New York at about $168,000, a slight decline from Tuesday’s all-time high of $169,000.

Timing is everything: chatter about the end being in sight for central bank bond buying has the US Treasury market chafing against efforts to keep benchmark yields subdued.

So far this month, the yield on 10-year notes – which moves inversely to price – has climbed nearly 40 basis points to just shy of the 2 per cent barrier, propelled by improving labour data and concern that the Federal Reserve may reduce its current $85bn in monthly mortgage and Treasury bond purchases.

The growing risk for the Treasury market is that stronger economic figures this summer could be a game changer in that it will only intensify the debate as to when the Fed should start curtailing quantitative easing.

“The bond market is not prepared for a debate about the end of QE,” says Zach Pandl, senior interest rates strategist at Columbia Management. “The market view is that QE continues until the end of the year and tapers next year, with a minority expecting an increase due to falling inflation.”

With equities charging to fresh daily peaks and investors underweighting their exposure to Treasuries in favour of riskier and higher yielding corporate bonds, the plus factors for government bonds remain the Fed’s hefty buying against the backdrop of lower inflation and an improving budget deficit. Inflation data on Thursday revealed price pressures had fallen to their lowest level in two years, boosting bond prices and lowering yields.

But in a break from recent years, the eurozone debt crisis and US political risk have receded as drivers of haven demand for Treasury debt, leaving the market focused on prospects for the economy and the Fed’s unorthodox monetary support.

“Economic growth expectations have become one of the key drivers for core government bonds yields this year, replacing anxiety about the eurozone and the US fiscal cliff,” says Dan Morris, global market strategist at JPMorgan Asset Management.

Also weighing on sentiment for Treasury debt has been the dramatic rise in Japanese government bond yields in recent weeks, as the world’s third-largest economy has entered the global reflation trade in a forceful manner, that if successful would mean much higher global bond yields.

“A major catalyst of the recent sell-off has been international,” says Mr Pandl. “A more favourable tailwind from the global economy would be good for the US and is another reason for the Fed to pull back from QE.”

At the very least, regular bouts of volatility beckon for the bond market in the next few months.

“The ongoing discussion of tapering, or more appropriately, adjusting QE3 will bring increased market volatility around data points, Fed meetings, and Fed Minutes,” says John Briggs, strategist at RBS Securities. “There will be a recurring risk that if, for example, payrolls next month is plus 200,000 or greater, then the markets will fear that the Fed will be ‘adjusting’ lower QE3 by an unknown amount.”

Lou Crandall, economist at Wrightson Icap, says the Fed may start cutting its monthly bond purchases as early as July, in the event that monthly payrolls register growth beyond 200,000.

“Starting this July would not preclude the Fed from still buying bonds the following July,” says Mr Crandall. “The key thing is that the Fed wants to avoid a sense of inevitability and get away from a predictable glide path for ending QE.”

For now Treasury yields have yet to top this year’s peak, but the 10-year is seen having scope to eclipse March’s high of 2.08 per cent as the market follows economic data and reacts to more speeches and meetings from Fed officials.

Mr Morris says 2.25 per cent on the 10-year note is the upper end of the range until the Fed’s message changes to indicate that a slowdown in QE purchases looms.

The risk for policy makers, however, is that the bond market could run ahead of itself in the event of better jobs numbers and send yields sharply higher. Such a turn of events could slow the housing recovery, ultimately weighing on the economy.

Clifford Corso, chief executive at Cutwater Asset Management says: “The reality is the Fed has to risk-manage their way out of this and I think they will drag their feet. The economy can’t handle a sharp jump in rates.”

While some policy officials are keen to start reducing the firepower of QE, many in the bond market doubt they want to run the risk of withdrawing support too early and scupper the chance of self sustaining recovery for the economy.

“The Fed has ended past periods of stimulus before the economy has recovered,” says Ian Lyngen, strategist at CRT Capital. “To us the tapering of QE is a fourth-quarter story.”

That outcome may well eventuate, but it won’t stop the bond market from trying to pre-empt a possible change in Fed policy.

“Confidence in the improving economy and a need to scale back stimulus seem to be the next logical steps if the data continue to improve, but the problem is one of timing and neither the Fed nor the market has a good sense of when that will be,” adds Mr Lyngen.

©Getty

Thursday 04.00 BST. Asian shares were mixed as a rise in the yen weighed on the Japanese market in spite of the country’s strong economic data while South Korean shares extended gains on foreign buying.

The MSCI Asia Pacific index advanced 0.2 per cent with South Korea’s Kospi Composite index up 0.6 per cent and Australia’s S&P/ASX 200 index slipping 0.1 per cent. Japan’s Nikkei 225 Stock Average fell 0.3 per cent after touching a five and a half year high on Wednesday.

The Japanese economy grew an annualised 3.5 per cent in the first quarter, the most in a year, as Prime Minister Shinzo Abe’s bold stimulus measures began to take effect. This is in sharp contrast with the eurozone, which suffered the longest recession since the single currency was born at the turn of the century, with unemployment hitting 12.1 per cent in the bloc. But gains were limited by a bigger-than-expected fall in US industrial output in April.

In Tokyo, banks lost ground as their earnings are forecast to fall on weaker loan margins, with Mitsubishi UFJ Financial Group dropping 3.4 per cent. Among property developers, Mitsui Fudosan rallied 4 per cent. Corporate earnings remained in focus, with Dai-Ichi Life Insurance surging 6 per cent after reporting bigger earnings and a stock split. Olympus climbed 12.7 per cent after the company said its net profit is expected to triple to Y30bn in the current fiscal year.

In Sydney, miners were under pressure due to weak commodity prices. Fortescue Metals Group slid 3.1 per cent following a drop in iron ore prices, while Newcrest Mining tumbled 5 per cent as gold prices continued to fall.

South Korean shares were buoyed by foreign buyers returning after having been net sellers for most of April and so far this month. Hyundai Motor extended gains, rising 1.0 per cent.

China’s Shanghai Composite index and Hong Kong’s Hang Seng index both inched up 0.1 per cent. Among active stocks, Tencent climbed 4.8 per cent after the Chinese internet company reported a robust 37 per cent jump in quarterly profit.

In currency markets, the yen was trading higher at Y102.06 per US dollar from Y102.25 in New York late Wednesday.

Earlier, on Wall Street, the S&P 500 equity index rose 0.5 per cent to a fourth successive record close. It reached an all time intraday high of 1,661 during the session. The S&P has now risen more than 16 per cent since the start of the year.

Additional reporting by Dave Shellock

Greece’s government bond yields tumbled to their lowest level in three years on Wednesday after an unexpected upgrade stoked optimism that the first and biggest casualty of the eurozone crisis is gingerly on the mend.

Fitch Ratings lifted its assessment of Greece’s creditworthiness by one notch to B- late on Tuesday and highlighted the country’s “clear progress” towards fixing its budget and trade deficits.

Standard & Poor’s already rates Greece similarly but the upgrade fuelled a rally in Greek financial markets, sending the benchmark 10-year bond yield down to just above 8 per cent and the Athens stock market to its highest close since August 2011.

“It’s been a tremendous trade,” said Arvind Rajan, a senior fund manager at Prudential, a big US insurer that holds some Greek bonds. “Greece isn’t out of the woods yet but there has been a lot of progress.”

Hedge funds have been among the biggest beneficiaries from the turnround in sentiment towards Greece because they snapped up government bonds for a fraction of their face value when many other investors feared the country would leave the currency bloc.

The benchmark 10-year bond traded at just 14 cents on the euro at the nadir that followed inconclusive elections last May but rose to 63 cents on the euro on Wednesday.

Investors keen to profit from a potential Greek recovery have helped several domestic companies regain access to debt markets, and hedge funds are helping recapitalise the banking sector.

Nonetheless, many investors remain wary of Greece, spooked by its mammoth debt pile – which Fitch expects to hit 180 per cent of gross domestic product by next year – and the murky outlook for economic growth.

The Greek economy shrank a further 5.3 per cent year-on-year in the first quarter of 2013, according to data released on Wednesday. Although most economists forecast that Greece’s wrenching five-year recession will end next year, creditors face further losses with few expecting a strong rebound.

Fitch conceded that the sustainability of Greece’s debts was “far from assured”, but predicted that the eurozone itself would likely bear the brunt of another restructuring, given that private creditors now only represent a small part of Athens’ debt burden.

Although that would be politically unpalatable in many European countries, the remaining bonds in the hands of private investors enjoy strong legal protections that would make them tough to restructure – which has buttressed appetite among hedge funds.

Niche securities with returns tied on Greek economic growth – issued as a consolation to bondholders that accepted painful losses in last year’s restructuring – have also rallied strongly, indicating that hedge funds are starting to place bets that a recovery is in sight.

The payment of these warrants are dependent on the Greek economy hitting certain nominal levels and real growth rates.

Given the depth of the depression, Deutsche Bank analysts do not expect them to start paying out before 2023, but their cheapness has attracted some investors. The price shot up to just over 1 cent on the euro on Wednesday, almost quintupling from the same time last year.