Bubble expert deems bond market fit to burst

Global Finance, Sep 2003 by Platt, Gordon

UNITED STATES

The bond market vigilantes are back. The steep rise in yields in global bond markets in recent months could threaten to derail the nascent economic recovery. Mortgage rates in the US already are creeping up and refinancing activity is slowing.

Robert Shiller, the Yale University economics professor who accurately forecast the technology bubble in the late 1990s, is turning his attention to a new bubble. Making the rounds of the TV talk shows, Shiller is warning that the bond market is in the same overvalued position as the stock markets in early 2000.

Most Wall Street economists are less concerned than some academics about a bond bubble. They say the selling that has clobbered bond prices since deflation fears eased in mid-June is merely a correction. It will take a more convincing upturn in economic data to confirm the US administration's optimistic forecasts, they add. Meanwhile, higher borrowing costs are being offset to some extent by the wealth-creating effect of a rising stock market.

Eventually, however, the need to finance a widening US budget deficit could give the bond vigilantes their day in the sun. That could trigger an even more serious collapse in prices and a steeper yield curve. US bond mutual fund assets have increased by $300 billion in the past two years, as antsy investors fled the bear market in stocks. The bond market's exits could suddenly look awfully narrow if everybody tries to get out at the same time. If the bond vigilantes get their way, the Federal Reserve could be forced into raising short-term rates sooner than it would prefer in order to prop up bonds. -GP