Bond Boss: why ChatGPT might be affecting your bond fund

What does ChatGPT have to do with the money investors earn from bonds?

At first, they seem unrelated. ChatGPT is a very smart chatbot. A bond yield is the return investors get when they lend money to governments or companies.

But the rapid growth of artificial intelligence (AI) may be helping to push bond yields higher.

If you have money in a bond fund, this is something worth watching.

The usual reasons

When bond yields go up, bond prices go down. Investors usually look at a few common reasons for this.

Maybe prices of everyday goods and services are rising faster than expected. This is called inflation. Or maybe central banks are keeping interest rates high for longer than people thought.

Another reason could be that the economy is growing faster, so investors want a bigger return for lending their money through bonds.

All these things are important.

But something else is happening too. It has less to do with inflation and more to do with a simple idea that economists have studied for hundreds of years: supply and demand, or how much of something is available compared with how much people want it.

Too many people borrowing and not enough people lending?

Governments and companies both need to borrow money.

Investors lend them money and expect to receive interest payments in the future.

When more governments and companies want to borrow, investors have more choices. In many cases, they will ask for a higher return before agreeing to lend their money.

For years, people worried mainly about how much governments were borrowing.

In many developed countries, governments have needed to borrow more money. This is partly because they spend more than they collect, their populations are getting older, healthcare costs are rising, and they are spending more on defence.

Governments have been borrowing more by issuing bonds. To persuade investors to buy these bonds, they have had to offer higher yields.

Investors already understand this problem. What many people may not realise is that governments are no longer the only ones borrowing huge amounts of money.

Now AI is growing fast

Building the technology needed for AI costs a lot of money. Data centres, which are large buildings full of computers, are expensive.

So are powerful computer chips, electricity networks and the other technology needed to run increasingly advanced AI systems.

In the past, many of the big technology companies leading this spending used money earned from their own businesses to pay for new projects.

But more and more of these companies are now borrowing money by selling bonds to investors.

This is important because some companies are borrowing such large amounts that they could affect the whole bond market.

This means governments now face more competition from companies when they try to borrow money from investors.

So what happens when governments and some of the world's biggest companies all try to borrow huge amounts of money at the same time?

Why this matters if you invest in bonds

The number of bonds being sold is only one part of the story.

At the same time that more bonds are being sold, some of the investors who usually buy them are becoming less willing to do so.

Central banks are no longer buying nearly as many bonds as they did during the period known as quantitative easing, when they bought large amounts of bonds to support the economy.

Some investors who used to buy bonds that take many years to repay, including pension funds, are also becoming less dependable buyers.

Investors are also starting to question whether bonds still help spread investment risk as well as they used to.

When you put all these changes together, the situation becomes clearer.

More bonds are being sold, but there is less certainty that enough investors will want to buy them.

If the number of new bonds grows faster than the number investors want to buy, bond yields may have to rise to attract enough buyers.

In simple terms, bonds may need to offer better returns to persuade investors to include them in their investments.

Are higher bond yields good or bad?

Higher bond yields are not always a bad thing.

If yields are rising because companies are investing more, workers and businesses are becoming more productive, and the economy is expected to grow faster, that is usually a good sign.

After all, money borrowed today could help pay for new technology that makes the economy stronger in the future.

But the situation is less positive if yields are rising because investors are worried about inflation, government spending and borrowing, or whether governments can keep managing their debts over many years.

The difficult part is that both of these things could be happening at once. That helps explain why investors have been paying so much attention to bond markets in recent months.

What should investors look out for?

For many years after the global financial crisis, investors got used to a world where prices rose slowly, interest rates were extremely low, and there were plenty of investors who regularly wanted to buy government bonds.

Things are different today. Governments still need to borrow a lot of money. AI companies also need more and more money to pay for their projects.

At the same time, investors are being more careful about where they put their money.

Higher bond yields can also give investors new opportunities. For example, company bonds that are due to be repaid sooner may provide good income through regular interest payments, known as coupons. Their prices may also move up and down less than the prices of bonds that take longer to repay.

But investors should not simply choose the bonds offering the highest yields. A very high yield may mean there is a greater risk that the borrower will fail to repay the money. This is called default risk.

Better opportunities may come from bonds issued by companies or other borrowers with strong finances. These bonds may offer enough income to make the risks worthwhile. That is why choosing bonds carefully is especially important.

Final thoughts

ChatGPT does not decide what bond yields will be.

But the huge amount of money being invested in AI may be changing the balance between the number of bonds being sold and the number investors want to buy around the world.

For investors, this extra competition to borrow money could also create chances to earn good income by choosing bonds carefully.

In the future, people who invest in bonds may need to pay almost as much attention to Silicon Valley, where many big technology companies are based, as they do to central banks.

Jonathan Mondillo is the global head of fixed income at Aberdeen, meaning he leads its work involving investments such as bonds.