Monday, February 04, 2013

Irwin: No Bond Bubble

by Bill McBride on 2/04/2013 11:11:00 AM

I was going to write about this since I'm asked about a "bond bubble" all the time - but Neil Irwin at the WaPo beat me too it: No, there probably isn’t a bond bubble

One peculiar legacy of the financial crisis is that, among the financial commentariat, there is a tendency to see a bubble whenever the market for a particular asset rises.
Yes - people see bubbles everywhere!
[N]o bubble fears are as widespread as the conviction that the markets for government bonds—in the United States in particular, but also in many other nations. It almost passes as a mark of seriousness to argue that Treasuries are the next big bubble to pop, the biggest in a long series that also included the stock market bubble of the late 1990s and the housing and mortgage securities bubble of the 2000s.

That kind of talk particular heats up whenever bond prices start to fall a bit, as they have in the last few weeks. (The phrase “bond bubble” appeared in major world publications included in the Nexis database 28 times in January—up from two in January 2012). And it is true that bonds have been in a remarkable 30 year rally, their prices climbing as interest rates have fallen almost constantly since the early 1980s.

It’s certainly true that bond prices could fall (and, conversely, longer-term interest rates rise). On balance, that is more likely to be for good reasons–because the economy is getting back on track–than for bad reasons, like inflation getting out of control.

But I’m not particularly worried that Treasury bonds are a bubble about to pop. Here’s why.

The first, and simplest reason to be skeptical of the bond bubble story is this: What defines a bubble is people buying an asset at ever-rising prices for speculative reasons, not based on the fundamental value of the asset, but because they are assuming somebody else will buy it at a higher price. I see no evidence of this behavior by buyers of Treasury bonds.
This reminds me of discussions we had back in 2005 about "what is a bubble"? Back then we were discussing the housing bubble (See: Housing: Speculation is the Key). Here is what I wrote about housing in April 2005:
I have taken to calling the housing market a "bubble". But how do I define a bubble?

A bubble requires both overvaluation based on fundamentals and speculation. It is natural to focus on an asset’s fundamental value, but the real key for detecting a bubble is speculation - the topic of this post. Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the "bubble" bursts.
With bonds, I don't see speculation, significant leveraged buying, "storage" or any of the other factors that defined a housing "bubble". I think Irwin is correct - there is no bond bubble, and when bond prices eventually fall (and interest rates rise) it will most likely "be for good reasons–because the economy is getting back on track".

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