Econ­o­mists see signs of an­other mar­ket bub­ble Fed’s low rates en­tice in­vestors

The Washington Times Weekly - - National - BY PA­TRICE HILL

Could the Federal Re­serve’s loose-money poli­cies be fuel­ing an­other fi­nan­cial mar­ket bub­ble like the one whose abrupt and painful end ush­ered in the last re­ces­sion?

A grow­ing num­ber of fi­nan­cial an­a­lysts be­lieve that’s the case. Af­ter nearly six years of the Fed hold­ing in­ter­est rates close to zero, crit­ics note that the cen­tral bank has largely failed to spark the stronger growth it seeks in the econ­omy while the U.S. stock and bond mar­kets are in­creas­ingly ex­hibit­ing the kind of “ir­ra­tional ex­u­ber­ance” that sig­naled mar­ket bub­bles in past decades.

“Cen­tral banks got what they wanted — in­vestors are act­ing as if there were no longer any risk,” thanks to the “tsunami of cen­tral bank-cre­ated money that is crash­ing ashore in var­i­ous as­set mar­kets,” said Pa­ter Tene­brarum, a fi­nan­cial blog­ger. He said the U.S. is in an “echo bub­ble era” ex­hibit­ing eerie sim­i­lar­i­ties to the mar­ket trends that led up to the global fi­nan­cial cri­sis of 2008, a cri­sis fed in part by low in­ter­est rates.

While many mar­kets, from stocks to col­lat­er­al­ized loan obli­ga­tions, are ex­hibit­ing froth­i­ness, “one can make an ed­u­cated guess as to where light­ning will likely strike next,” he said. “It is likely cor­po­rate debt where trou­ble will rear its head” as cor­po­ra­tions is­su­ing junk-rated bonds have been among the big­gest ben­e­fi­cia­ries of the lat­est mar­ket craze.

A re­port late last month from a top fi­nan­cial watch­dog group made the case that the Fed and other ma­jor cen­tral banks are in­flat­ing the be­gin­nings of a bub­ble in many stock and bond mar­kets world­wide. It as­serted that the stel­lar per­for­mance and everup­ward march of stock in­dexes into record ter­ri­tory in the U.S. and else­where in the past two years seem dis­turbingly out of sync with the sober­ing lev­els of el­e­vated un­em­ploy­ment and mod­est growth seen in the Main Street econ­omy.

“Global fi­nan­cial mar­kets are un­der the spell of mon­e­tary pol­icy,” the re­port from the Swiss­based Bank for In­ter­na­tional Set­tle­ments pro­claimed, not­ing that the ul­tralow in­ter­est rates main­tained by the Fed and its coun­ter­parts in Europe and Ja­pan have en­cour­aged and even forced in­vestors to take on in­creas­ing lever­age and greater risks in their search for higher yields.

In their stam­pede to lock in higher re­turns, in­vestors have rou­tinely ig­nored bad news such as the nearly 3 per­cent con­trac­tion in the U.S. econ­omy at the be­gin­ning of the year and the out­break of civil war in Iraq and Ukraine.

“Over­all, it is hard to avoid the sense of a puz­zling dis­con­nect be­tween the mar­kets’ buoy­ancy and un­der­ly­ing eco­nomic de­vel­op­ments glob­ally,” said Clau­dio Bo­rio, mon­e­tary an­a­lyst at the Swiss bank.

Bill Gross, the man­ager at Pimco, the world’s big­gest bond fund, re­cently ex­plained the dilemma for the world’s savers and bond­hold­ers cre­ated by the Fed’s sup­pres­sion of in­ter­est rates. The Fed is in­ten­tion­ally giv­ing a strate­gic ad­van­tage to debtors to try to spur greater growth through ex­panded credit and risk-tak­ing in the econ­omy, but in the process it is pun­ish­ing savers with mea­ger re­turns on their bank de­posits and other in­vest­ments.

The Fed’s low-rate poli­cies have made it un­prof­itable for re­tirees and other savers to buy and hold long-term bonds such as 10-year Trea­surys, which cur­rently yield lit­tle above the longterm 2 per­cent rate of in­fla­tion. Short-term se­cu­ri­ties pro­vide even more pal­try re­turns. Thus, to aug­ment re­turns, Mr. Gross said, Pimco and other fund man­agers are “fight­ing back” by go­ing deeply into debt, tak­ing on short-term loans at near-zero rates so they can take mas­sive po­si­tions in long-term bonds and pump up the yields on their in­vestors’ funds.

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