Alan Greenspan has a warning for bond investors as the U.S. central bank prepares to raise its benchmark interest rate from close to zero.
“We have a pending bond market bubble,” the former Federal Reserve chairman said Monday in an interview on Bloomberg Television. “What ultimately will determine where it goes is to reach back and to ask ourselves where is the normal interest rate?”
Treasury yields have been anchored by the Fed’s policy of keeping its main interest rate close to zero since 2008 to support the U.S. economy. The Fed’s benchmark, the target for overnight lending between banks, has averaged about 2.70 percent in the past 20 years.
Benchmark U.S. 10-year note yields fell five basis points, or 0.05 percentage point, to 2.18 percent as of 10:27 a.m. London time, according to Bloomberg Bond Trader data. The price of the 2.125 percent security due in May 2025 rose 13/32, or $4.06 per $1,000 face amount, to 99 1/2.
Ten-year note yields are about half their average over the past two decades and are within a percentage point of a record low set in 2012. They will climb to 2.82 percent by the middle of next year, according to a Bloomberg survey of economists with the most recent forecasts given the heaviest weightings.
Speaking in an interview on Bloomberg’s “Surveillance” with Tom Keene, Greenspan also said low productivity was one of the major challenges facing the U.S. and other advanced economies. Greenspan was Fed Chairman from 1987 to 2006 and is now a private adviser. It was in December 1996 that he made the words “irrational exuberance” a euphemism for bubble.
Greenspan guided the U.S. economy through January 2006, at a time of growth in so-called “subprime” lending, or loans that carry higher rates of interest to compensate for increased credit risk.
Subprime mortgage defaults later infected the global economy, freezing lending markets and helping lead to the biggest U.S. recession since the Great Depression.
“I knew something was brewing, but I missed the actual date as in, frankly, did everybody else,” Greenspan said in his interview Monday.
As Fed Chairman, Greenspan gave the financial markets a new buzzword, saying it was a “conundrum” that long-term Treasury yields were falling in 2004 while the Fed raised borrowing costs.
“This development contrasts with most experience, which suggests that, other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields,” Greenspan said in testimony prepared for U.S. lawmakers.
A similar thing is happening now, with 10-year yields falling 30 basis points from this year’s high even as the central bank prepares its first increase in nine years.
There’s a 50 percent chance the Fed acts at its Sept. 16-17 meeting, based on the assumption that the benchmark rate will average 0.375 percent following the increase, data compiled by Bloomberg show.
Investors can look to “behavioral economics” to explain interest rates, Greenspan said in his interview Monday. “This particular question of what the optimal interest rate is is a behavioral issue,” he said.