Learn > [REN #324] Greenspan Warns of Bond Bubble and Rising Interest Rates
There is no stock bubble, according to former Fed Chief Alan Greenspan. He spoke out last week saying there’s a “bond bubble” and when it pops, it isn’t going to be pretty — especially for long-term interest rates. But not everyone agrees with him.
The former Federal Reserve Chairman spoke with Bloomberg News, saying, “Real long-term interest rates are much too low and therefore unsustainable.” The chairman continued, “When they move higher they are likely to move reasonably fast.”
Despite a “not so robust” economy, he expects inflation to rise at the end of this year, in step with the central bank’s plan to sell off government bonds. The Fed’s balance sheet ballooned to $4.5 trillion when the government implemented its “quantitative easing” policy during the economic crisis. It used money it didn’t have, otherwise known as printing money, to buy a total of $3.7 trillion in Treasurys and mortgage-backed securities from lending institutions. That gave the banks more liquidity to make loans, to bring down interest rates, and to encourage economic activity.
While many feel that the QE strategy helped stop the economic hemorrhaging, they say it’s done little to fire up the economy. Financial institutions were not required to make loans, and lending has been tight as banks deal with tough Wall Street regulations. Now the government is planning to put its QE program into reverse. While some people believe it will hit the stock market hard, Greenspan says it’s going to hit “bonds” first.
Greenspan doesn’t believe that stocks are overvalued right now. He told Bloomberg that: “We are experiencing a bubble, not in stock prices but in bond prices.” He says of the bond market: “This is not discounted in the marketplace.”
Greenspan says when the bond market collapses, the interest rates will rise. He says: “We are moving into a different phase of the economy — to a stagflation not seen since the 1970s. That is not good for asset prices.”
This means, according to Greenspan, that inflation and rising interest rates will also hit stock prices, along with bonds. He says if interest rates start rising quickly in response to inflation, investors should get out of stocks.
Although some economists feel that Greenspan’s prognostication is “ominous”, they say it’s not a big surprise. MarketWatch points out that Greenspan had issued a previous warning about a bond bubble last year. It quoted Stifel economist Lindsey Piegza as saying that the former Fed Chief has been quote “puzzled by low rates and low inflation for decades.”
Skeptics Don’t Anticipate Inflation
Greenspan’s belief that inflation will pop the bond market bubble, and that higher interest rates will then upset the stock market, are not shared by everyone. MarketWatch published an opinion piece that says there’s not a shred of concern about inflation anywhere in the bond market.
Columnist Carolina Baum says the ten-year inflation forecast has remained below the Fed’s 2% target for the last three years, except for one brief moment. She also says that Greenspan’s view runs contrary to that of the current Fed Chief Janet Yellen, and several other Fed officials. Instead, they’ve been mostly concerned about a lack of inflationary pressure, or possible “deflation”.
Baum says that Greenspan may be disappointed if he expects a period of stagflation like that of the 1970’s. Stagflation occurs when inflation rises despite a lack of economic growth. Although there are some similarities, she says there are more differences.
Among the similarities, she says that central bankers have bought inflation down and have kept it down. On the negative side, annual labor force growth is a paltry .6% compared to 1.5% during the 70’s. Baum blames that on retiring baby boomers.
She says this is important because labor-force growth and productivity can help an economy grow without creating an inflationary side-effect. The U.S. Labor Department has pegged unemployment at 4.4%, which is very low. However, as Baum points out, that number doesn’t include people working part-time who would like to work full-time or other people who’ve dropped out of the market altogether.
She implies that that the employment situation hasn’t truly been strong enough to keep inflation as low as it has been, and the Fed should do more to understand what forces are at play. She doesn’t believe there’s a risk that it will suddenly mushroom to new heights.
Thomas Byrne at Wealth Strategies & Management also expressed skepticisim in a Barron’s blog. He says, “Although I believe that there is room for a long-term rates rise, I think the rise should be limited.” He also says, “I believe that there is sufficient structural disinflationary forces to prevent an upward surge inflation.”
He also implies that the Fed’s plan to sell bonds could reduce inflationary pressure, and wonders if Greenspan takes into account important market forces like aging demographics, and high tech advances — both of which set the current situation apart from the one that happened in the 1970’s.
What does this mean for real estate investors?
Some say we’re in the 9th inning of the economy, and that recessions happen every 10 years. Others say we are poised for an economic boom with the Trump administration’s pro-business policies.
I say, plan for either scenario. Make sure your portfolio can withstand a possible recession, and that it can benefit from a potential boom.
Most assets increase in value in a booming economy. Cash flow properties in areas with strong job diversification tend to fare well during recessions.