Is ex-Fed Chief Greenspan’s New Bond Bubble Warning, ‘Irrational Exuberance,’ Déjà Vu?
Add ex-Federal Reserve Chairman Alan Greenspan to the list of experts warning about a bond market bubble. Speaking in late July to Bloomberg News, Greenspan warned, “Equity bears hunting for excess in the stock market might be better off worrying about bond prices… That is where the actual bubble is, and when it pops, it’ll be bad for everyone.”[i]
On December 5, 1996, Greenspan made a similar warning about “irrational exuberance” in stock prices. Four years later, in 2000, Greenspan’s concern about stocks was proven somewhat correct as the Nasdaq began its 78% fall in price—but only after it had gone up over 200% in price from 1996-2000.
Many have made similar predictions about the direction of interest rates
- Sheyna Steiner, “Prepare Your Portfolio for Rising Interest Rates,” Fox Business, 24, 2013, http://www.foxbusiness.com/features/2013/09/23/prepare-your-portfolio-for-rising-interest-rates.html
- Kimberly Palmer, “How to Prepare for Rising Interest Rates,” S. News & World Report, Aug. 28, 2013, https://money.usnews.com/money/personal-finance/articles/2013/08/28/how-to-prepare-for-rising-interest-rates
- Nathaniel Popper and Peter Eavis, “In a Shift, Interest Rates Are Rising,” The New York Times, June 11, 2013, https://dealbook.nytimes.com/2013/06/11/in-a-shift-interest-rates-are-rising/
- Martin Feldstein, “U.S. Interest Rates Will Continue to Rise,” Project Syndicate, 28, 2013, https://www.project-syndicate.org/commentary/the-sources-of-upward-pressure-on-us-interest-rates-by-martin-feldstein?barrier=accessreg
These reports represent an almost universal view that stronger economic growth will lead to higher interest rates. In 2013, interest rates did rise. Using the ten-year Treasury bond as a proxy, on January 1, 2013, its yield was 1.84%, and by year-end it was 3.03%.
However, something interrupted the rising interest rate story. The ten-year Treasury bond that ended 2013 at 3.03% is yielding around 2.26% today. Rates declined, even though the Federal Reserve eliminated their bond-purchasing program (QE). The conventional wisdom was: When the Fed stopped buying bonds, interest rates would rise.
Greenspan is not alone
A couple of days after Greenspan made his latest proclamation, key members of two financial service giants, the Vanguard Group and Blackrock, raised similar concerns. Vanguard Senior Money Manager Gemma Wright-Casparius reports, “The underlying trends in core inflation will be higher.” Vanguard manages $4 trillion.[ii]
BlackRock’s Martin Hegarty prefers inflation-linked Treasury bonds to British or European bonds, suggesting that bond traders are in error if they presume that inflation in the U.S. will remain depressed.[iii]
One day after those concerns, we heard the following from Jamie Dimon, CEO of JPMorgan Chase, the largest U.S. bank: “”I’m not going to call it a bubble [bond market], but I personally wouldn’t be buying a 10-year sovereign debt anywhere in the world.”[iv]
Greenspan fears stagflation
One of Greenspan’s arguments is: since rates are at historic lows, they have but one direction to go. While his math is right, interest rates do not go up simply because they are low.
They rise because bondholders begin to fear inflation. A bond paying, say, 2% does not look so good if the cost of living (inflation) is 4%. If that were to happen, some investors would sell their bonds, thereby driving down the price of previously issued bonds.
Greenspan goes two steps further: (1) He worries that rising rates will eventually cause people to sell stocks, thus pushing stock prices down, and (2) he predicts that higher inflation, together with slow economic growth, could bring about stagflation—something the U.S. has not seen since the 1970s.
Will the Federal Reserve be the catalyst?
Greenspan, Dimon, and others believe that a catalyst for a selloff in the bond market could come from the Fed’s desire to reduce its balance sheet, and that the only way for them to do so is to sell a portion of the trillions of dollars of bonds they had purchased during QE. Greenspan and Dimon worry that these additional bonds for sale could force interest rates higher and possibly cause a panic in the bond market.
My guess is, much like those 2013 predictions mentioned above, these new predictions of rising inflation causing a spike in interest rates rather than a sell-off in the bond market will fail to come true, because of the factors keeping inflation low: excessive levels of private debt, the lack of power for labor vs. capital, and high levels of oil production.
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice
[i] Renick, Oliver, and Liz McCormick, “Greenspan Sees No Stock Excess, Warns of Bond Market Bubble,” Bloomberg News, July 31, 2017, https://www.bloomberg.com/news/articles/2017-07-31/no-bubble-in-stocks-but-look-out-when-bonds-pop-greenspan-says
[ii] McCormick, Liz, “BlackRock, Vanguard Say Bond Market’s Got This Trade All Wrong,” Bloomberg News, August 7, 2017, https://www.bloomberg.com/news/articles/2017-08-06/blackrock-vanguard-say-bond-market-s-got-this-trade-all-wrong
[iv] Lovelace Jr., Berkeley, “Jamie Dimon: I Wouldn’t Buy a 10-Year Bond from Any Country in the World Right Now,” CNBC, August 8, 2017, https://www.cnbc.com/2017/08/08/jamie-dimon-wont-call-it-a-bubble-but-i-wouldnt-buy-bonds-here.html