bond bubble

3 bond bubble theories that don't hold up

April 10, 2013: 5:00 AM ET

Top strategist at Blackrock says the economy is stronger than it looks, which will lead to rising interest rates and pain for debt investors. But the evidence otherwise is too strong.

bernanke-fedFORTUNE -- Ben Bernanke is missing the recovery.

That's the view of Blackrock strategist Rick Rieder. In an interview with the Financial Times, Rieder, who is officially Blackrock's chief investment officer for fixed income, fundamental portfolios, said it's time for the Federal Reserve to scale back, by half, its efforts to stimulate the economy. He called the Fed's tactics a "large and dull hammer," that is distorting markets.

As such, the FT says Rieder's comments add Blackrock to the growing list of "Fed critics" who are worried about a bond bubble.

Perhaps, but it's important to note why. Unlike others, Blackrock's strategist doesn't believe the Fed's bond buying efforts are failing and will cause the dollar to plunge in value, taking the economy with it. (Buy Gold!) Instead, the reason Blackrock is nervous about the bond market is because the efforts to boost the economy -- by the Fed and others -- along with a more positive business cycle appear to be producing results. More than the Fed thinks. (Buy stocks, I guess.)

MORE: Why the Fed can't help the long-term unemployed

In a recent note to clients, Rieder pointed out three reasons why he thought the economy was stronger than it appeared:

  • The U.S. energy industry is taking off. New technologies to extract oil and gas will lower prices and add 3.6 million jobs in the U.S. by 2020. It will also lower our trade deficit. This is a favorite point of Blackrock's CEO Larry Fink as well. Fink has predicted that cheap natural gas could lead to a manufacturing boom in the U.S.
  • Housing! Rieder says the real estate rebound may add 2% to GDP in 2013.
  • Corporations have recently indicated that they plan to step up expenditures. That along with the resurgence of the U.S. consumer, should put the U.S. economy into overdrive.

All told, Rieder says, citing research firm ISI, the economy could grow 3.3% in 2013. That's better than the Fed's own forecast, which puts the range of economic growth between 2.3% and 2.8%. Once the market realizes this, Rieder believes interest rates will rise and bond prices will fall.

Here's the problem: Most of Rieder's points have recently been debunked. The New York Times's, Nelson Schwartz recently wrote that the drop in energy prices has yet to stem the flow of manufacturing jobs out of the country. As for housing, a 2% contribution to GDP might sound good. But economist Dean Baker points out that's still way down from the 6% that housing used to kick in a few years ago. Baker says Wall Street remains too bullish about the the job market.

MORE: The ticking time bond in bond funds

Lastly, the evidence that companies are about to spend all that cash they have been hoarding through the recession is mixed at best. Indeed, many people think much of that money because of tax reasons may be stuck overseas.

But the biggest problem with Rieder's bond bubble thesis is this: Interest rates and the economy are only marginally connected. Rates have generally fallen over the past three decades, despite some rather robust periods of growth.

It's not that I don't believe interest rates will eventually rise, and that when they do a number of investors will be caught off guard. Still, with all the talk about the bond bubble recently, some cold water might be in order.

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  • Buffett hints at bond bubble

    Investors buying bonds at the prevailing high prices are 'making a mistake,' billionaire investor Warren Buffett said.

    Buffett, speaking Tuesday at Fortune's Most Powerful Women Summit in Washington, said it's "quite clear stocks are cheaper than bonds" now. He added that he "can't imagine" the rationale for adding bonds to your portfolio at current prices.

    The Berkshire Hathaway (BRKA) chief made the remarks in an interview with Fortune's Carol Loomis at the 12th annual summit. He MORE

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  • Sovereign debt for dummies

    It's only a matter of time till runaway debtors such as the United States hit the wall, investor Rob Arnott argues.

    Arnott, who runs the value-focused Research Affiliates investment manager in Newport Beach, Calif., writes in his monthly newsletter that it's imperative that bond investors diversify away from debt-soaked rich countries such as the United States.

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  • The unpoppable bond bubble

    Wharton's Jeremy Siegel warns that we're in for a titanic bond bust. But it could take years for this ship to go down.

    Bond prices have been soaring since U.S. job growth hit a wall in June. Yields on government bonds have dropped to levels last seen in March 2009, when stocks were still reeling from the post-Lehman Brothers bust. The 10-year Treasury yielded 2.6% Wednesday, down from 4% just four MORE

    - Aug 18, 2010 3:41 PM ET
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