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Bubble or not -- bond market harbors risks   2013-05-14 15:11:29

  A debate has heated up over whether a bubble is building in the U.S. bond market, with the consequent risk of another financial crisis.

  But at least all agree the Federal Reserve's exit strategy for its quantitative easing (QE) policy is a source of uncertainty in bond and other markets. The later the Fed discards the policy, the more likely a bond bubble will emerge.


  The Fed's commitment to loose monetary policy was likely to lead to asset and equity bubbles in the next two years, which could be worse than the previous crisis, said Nouriel Roubini, the New York University economics professor known as "Dr. Doom" for his accurate prediction of the 2008 financial crisis.

  The Barclays U.S. Corporate High Yield Index last week fell below 5 percent, the lowest since 1987, with prices in junk bonds soaring to record highs, as investors shifted money to riskier assets.

  A bear bond market was likely to start after its 30-year bull run, David Yan, director of fixed income research at Credit Suisse Securities (USA) LLC, told Xinhua.

  His remarks were echoed by Pacific Investment Management Co. co-founder Bill Gross, nicknamed "The Bond King" in media outlets, who posted on Twitter the 30-year bull market for bonds had probably ended as yields reached a low and prices peaked.

  The bond markets would crash once global central banks stopped buying debt, triggering a financial crisis much worse than the one seen in 2008, David Roche, Global Strategist at Independent Strategy, said on CNBC last week. He has previously warned that "safe haven" government bonds are the most dangerous place for investors.


  However, some senior portfolio managers and analysts argue it is not reasonable to assert there is a bubble in the bond market due to its unrealistically high price and unrealistically low yield.

  "Though I'm a little bit concerned with risks in the bond market, I don't see a bubble yet," L. Kevin Chen, portfolio manager at TIAA-CREF, a full-service financial services company, told Xinhua.

  Rosenblatt Securities Inc managing director Gordon Charlop told Xinhua some investors had an appetite for bonds in the credit market, which was in a boom cycle right now. But he did not think there was impending doom.

  "I think it's over simplification, a little dramatic," said Charlop, who was skeptical of bubble theorists.

  Paul Krugman, a Nobel laureate and notable economist, wrote last Thursday in his column in the New York Times there was "definitely" no bubble in bonds and "probably" no bubble in stocks.

  And BlackRock's Chief Fixed Income Investment Strategist Jeffrey Rosenberg told Xinhua: "The market will likely sell off on indications of reduction of (bond) buying, but it will not crash. However, the threat of a crash upon indications of selling means that selling will not happen."


  Despite wide divergences as to whether there is a bubble in the bond market, there seems to be no doubt that risks are increasing for U.S. bonds amid uncertainties about the Fed's scaling back of its massive bond-buying program and market anxieties stemming from the uncertainties.

  Yan predicted the bond market could react in advance to the Fed's actual retreating from its aggressive monetary policies. "The central bank would withdraw within two years, and the question is how it will exit?" he said.

  The Fed said in a statement after its latest policy-making meeting it anticipated the exceptionally low federal funds rate would be appropriate at least as long as the unemployment rate remained above 6.5 percent and inflation expectations continued to be well anchored.

  Though it will take considerable time to accomplish the Fed's economic targets, the market is speculating it may taper its QE earlier than expected.

  And the Fed is in fact in a dilemma. On the one hand, an abrupt or earlier end to the QE could hamper economic recovery and cause huge volatility in stocks and bonds. On the other, a delayed end could allow markets to overheat and eventually evolve into a bubble.

  Rosenberg said the consequences of such a large Fed balance sheet complicated its ability to tighten policy when the time came.

  "While we don't think there is a crash (in the bond market), we also don't see yields compensating you for that risk, which is low. So reduce Treasury exposure in a portfolio in favor of private market exposure where yields offer better compensation for the risks," Rosenberg advised investors.

source : Xinhua     editor:: Ma Ting
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