Are you thinking about the Fed? About the bond market? The stock market? The economy?
Say “yes” to any of the above and this is a chart you’ve pulled up: Fed funds and the 10-year, the two most closely watched financial readings (fine, one is a policy measure, but these are the tails that wag the market’s dog).
Right now, rates seem ridiculous low and there is more and more chatter about a bubble in bonds, particularly government bonds.
I think Robert Shiller’s comments are interesting.
“[The bond market] doesn’t clearly fit my definition of ‘bubble.’ It doesn’t seem to be enthusiastic. It doesn’t seem to be built on expectations of rapid increases in bond prices.”
“Expectations of rapid increases in bond prices.”
A lot of people now are worried about a bond bubble, partly because worrying about bubbles is a sort of an anomalous thing a lot of investors have become conditioned to worry about given how the last 15 or so years have gone in markets, and partly because bond yields have gone lower — and therefore prices higher — than pretty much everyone expected.
But Shiller’s comments about expectations of rapid increases in prices is something that is important to keep in mind. Because the thesis, generally, that backs up the argument for the current government bond bubble is that rates are artificially or inappropriately low (pick your adverb), but they will rise quickly and sharply and in due course.
But why must they rise?
Look at the chart above.
Every tightening and easing cycle has its own story, but the fact is that yields aren’t going anywhere until the Fed goes anywhere. And so if you don’t think the Fed is going to raise interest rates anytime soon, or at least don’t think the Fed is going to move aggressively when it does begin to move off the zero lower bound, then why would you be scared about an exploding bond bubble?
Look at the 10-year yield above and you’ll see the nasty spikes in 1994, and again in 1998/9, and to a lesser extent in 2013.
It’s been a 30-year bull market in Treasuries but it hasn’t been smooth all the way. And no matter where yields go from here, it won’t be an orderly process.
So if the Fed gets around to tightening before the next recession then we might see yields rise sharply but eventually begin trending lower as the cycle turns.
(This is, of course, if market history repeats itself, which presents its own set of problems because market expectations are based entirely on logically problematic inductive reasoning and so on. There will be posts on this issue later.)
Or maybe when the Fed tightens yields won’t rise at all. Or maybe they will keep falling. No matter.
The point-all here is that the idea of a bond bubble is predicated on bond prices being too high, and yet every forecast is for higher yields (and lower prices).
Someone on Twitter who I think is really sharp made some comments yesterday about long-term developed market bonds, calling them an unattractive investment long-term.
And this is actually probably right. (You should really follow that link.)
Buy a 10-year note today and you get less than 2% (1.97% as of 1/7/2015, to be exact) of your principal back every six months for the next decade: are you really going to beat inflation the whole way? Seems like a big ask.
Unattractive investments, however, don’t make bubbles.
Bubbles are about the seemingly infinite expectations of higher prices, not about valuations that don’t “feel right.”
And so sure, if yields were to rise — or keep falling for that matter — a number of ill-positioned market participants could suffer great damage.
But to me, a bursting bubble is about the whole artifice coming down at the same time because something the market never believed could happen actually did.