Remember the tech stock bubble? Then came the real estate bubble which is still deflating. Now we see the top of the U.S. Treasury bond bubble.
First, let's recall some characteristics of the bubble in tech stocks. Tech stock prices inflated to amazing heights when everyone was buying them. I recall shows on PBS describing people buying stocks who didn't even know the name of the firms they traded. Others quit jobs to day trade stocks. The demand for these stocks was unprecedented. This demand fostered a massive new supply of tech stock IPOs. The realization that prices were overvalued combined with the new supply of stocks (many were low quality companies) eventually led to the panic selling and price deflation. Within nine months, the Nasdaq index had lost half its value.
Now let's look at the real estate boom. At some point, the demand for houses increased more than usual. People who normally couldn't afford a home were given the chance to buy one. TV shows came out showing people owning many homes and ‘flipping' them. People who had a bad experience with stocks were putting their investments into real estate. Again, when prices and demand go up, so too will supply--eventually. Construction companies started building new neighborhoods and condo buildings. Again, this became unstable. The deflation of the real estate bubble will take much longer than that of the tech stock bubble. This is because transacting in the real estate market take much longer than transacting in the stock market.
During this difficult time, Treasury bonds have experienced a price bubble. Prices are historically very high, which means that interest rates are historically low. The demand for Treasuries from everyday folk has skyrocketed. Out of fear, many investors have run to Treasury securities. Some of those investors may not even know they have done so. They simply have taken what is left of their stock portfolio money and transferred it into money market funds and accounts. The short-term rates are less than 0.5% annualized, the 10-year note is at 3.5%, and the 30-year bond is at 4.3%. We have the demand that has driven prices high (and yields low). Do we have the characteristics for a pop in the bubble?
From the tech bubble and real estate bubble examples, it is clear that for the bubble to burst, we need both the Treasuries to be overvalued and a large new supply. First, let's look at the overvalued issue. I believe that the price has been driven artificially high from the high demand. I also believe that ‘quantitative easing' going on, which amounts to printing money, devalues US dollar securities. These two things together suggest an overvalued Treasury market. What about new supply? That one is easy. The rapidly increase budget deficit combined with the more funding needed for the stimulus bill means more supply. Additional spending programs (like health care) will just add more supply. In the longer-term Social Security and Medicare needs will greatly increase supply.
When will this occur? I don't know. Bubbles often last for quite awhile. But I think that when this one bursts, it will behave more like the tech bubble rather than the real estate bubble. This is because Treasuries are so easily traded. If foreign investors (like China) decide to sell, or even stop buying, prices will move quickly.
What are the ramifications of a price burst in the Treasury market? First, it would mean that interest rates skyrocket. This would harm the real estate market again because few would be able to afford the higher cost of a mortgage. Since much of the US government debt is borrowed short-term, it will quickly find it has to pay much higher interest. This will make the budget deficit even greater, so more bonds will have to be issued. This could be an ugly feedback loop.
