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The Picture Worth $6 Trillion: Bond Bubble

Ed Yardini:

Presumably, among the risks of QE are speculative debt-financed asset bubbles. However, last week, Janet Yellen said, “At this point, I don't see a risk to financial stability, although there are limited signs of a reach for yield.” She said that based on current valuations, stocks aren’t “in territory that suggest bubble-like conditions.”

I see more bubble-like conditions than Janet Yellen does. Her lack of concern may be justified currently, but by expressing it she increases the odds of triggering melt-ups in asset markets, especially if she turns out to be even more dovish than Bernanke, as I expect. Consider the following:


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why are corporate bonds necessarily in a bubble?


Don’t have a specific reason

But all corporate bonds trade at a yield spread above so called risk free treasuries. So if the 10 yr Treasury is 3% and a 10 corporate may trade at let’s just say 4 %. If the treasury were to slip in price to 5% then the corporate would be at least 6%. That’s if the margin of the spread stays at 1%.....a move on a percentage basis from 3% to 5% would be 66% move….so the selloff maybe to 6.68%. What I am trying to say is the move may be symmetrical in percentage term rather than in absolute terms. So by default if there is a bubble in the Treasury market…..unless there is a severe downgrading of treasury bonds then corporate bonds will continue to trade on a spread that can result in bubble like dynamics in the market. It may not hold forever but the risk is there until the bubble in the treasury market is corrected…..oh BTW…..The GSE bonds are now backed by the government and represent the same risk until the bubble pops too.

Hey Dog,

Do you know of Doug Noland? His work is so much more indepth then Yardini. Doug has been writing on the bubbles since 94 with a weekly post called the Credit Bubble Bulletin.


It is paramount for a central bank to recognize Bubble Dynamics early before they foment major financial excess – before they inflict deep impairment upon economic structures – before they gain powerful constituencies (as monetary inflations invariably do). And I strongly believe this key regulatory role became wholly impractical when market-based Credit (as opposed to traditional bank lending) assumed such a prevailing role in Credit systems and economies (at home and then abroad).

Indeed, what commenced during the Greenspan era only accelerated throughout Bernanke’s chairmanship: Progressively, Federal Reserve policymaking directly targeted the securities markets and asset inflation as its prevailing monetary policy transmission mechanism. And here we are today, with top Fed officials having stated that the Fed is prepared to “push back” against a “tightening of financial conditions” with even larger quantities of QE. The harsh reality is that Bubble markets will eventually burst with a problematic tightening of “financial conditions” commensurate with the excesses of the preceding boom. And there is simply no precedent for a global securities Bubble fueled by Trillions of central bank liquidity and bolstered by promises of ongoing liquidity backstops. And the greater the Bubble, the tighter the noose becomes around the necks of the markets’ central banker hostages.
From Dr. Yellen’s prepared remarks to the Senate Banking Committee: “A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

The new chairperson’s hopeful view is detached from reality. In a critical upshot of years of flawed policymaking, central bank liquidity these days greatly prefers Bubble securities markets to real economies. Having now fueled a full-fledged global securities market Bubble, there will be no “returning to a more normal approach to monetary policy.” It’s a myth in the same vein as the Fed’s 2011 “exit strategy.” It’s now a matter of how long until this “how crazy do things get” market phase runs its fateful course.

I sympathize with Dr. Yellen. Her predecessors were never held accountable. Deeply flawed economic doctrine has yet to be called out. History’s greatest monetary experiment has not yet run its course. Inflationism, with the contemporary version cloaked in sophisticated and elegant rationalizations, is widely accepted by policymakers, Wall Street, the media and popular commentators alike.

Meanwhile, the great flaw in discretionary monetary policymaking has come to fruition: a major error has ensured a series of ever greater policy blunders and a course toward catastrophic failure. It’s an unbelievable fiasco - and I don’t see how this historic Bubble doesn’t burst on her watch.