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The Fed has been ambiguous on potential interest rate increases. Learn why a interest rate could lead to the next crisis -- the bond market bubble.

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The Bond Market Bubble That Everyone Fears

The Fed has been ambiguous on potential interest rate increases. Learn why a interest rate could lead to the next crisis — the bond market bubble.

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When it comes to talk of a market ‚??bubble,‚?Ě it‚??s not equities that are the real worry among the smart money.

Sure, stocks in the Dow, S&P 500 and NASDAQ Composite all are trading near their all-time highs. But despite the lofty values, you don‚??t really get the sense that stocks feel ‚??bubble‚?Ě-like.

The real worry for a bubble is in the much bigger bond market.

Indeed, we’ve been hearing for years now about a possible bubble bursting in the bond market, and in particular the U.S. Treasury bond market. The reason actually is quite simple, and it has a lot to do with central banks and interest rates.

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While the Federal Reserve, the European Central Bank and the Bank of Japan don‚??t directly control bond yields, each of these key central banks sets policies that make investors choose certain asset classes over others.

During the past several years, ever since the ‚??Great Recession‚?Ě started in about 2009, we‚??ve seen central banks around the globe go into hyper-easing mode. That‚??s made long-term Treasury and other government bonds attractive despite the pitifully low yield they pay.

It also has made bonds a virtual ‚??growth‚?Ě asset over the past several years, as capital appreciation has been great if you own bonds like those in the iShares 20+ Year Treasury Bond (TLT). That fund is up some 20% over the past five years, and that doesn‚??t include the yield.

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Yet as we told you last week, this time it could be different for bonds, as the Federal Reserve is looking as though it will hike interest rates at least once this year.

While no rate hike is expected when the Federal Open Market Committee (FOMC) issues its statement on Wednesday, all market watchers will be looking to see if the Fed gives us any hints of a rate hike in December. Right now, the market is placing the odds of a December hike at about 50%.

Such a hike likely would cause bond prices to fall and bond yields to rise, and that is what so many bond bubble theorists are afraid will trigger the beginning of an exodus from the bond market such that the bond prices will continue falling and bond yields will continue rising.

That could cause a bursting of the bond bubble, and that‚??s the theory of a lot of really smart bond fund managers, including Jeffrey Gundlach of DoubleLine Capital.

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Written By

Doug Fabian is the editor of Successful Investing and High Monthly Income, and is the host of the syndicated radio show, "Doug Fabian's Wealth Strategies." Taking over the reigns from his dad, Dick Fabian, back in 1992, Doug has continued to uphold the reputation of the newsletter as the #1 risk-adjusted market timer as ranked by Hulbert‚??s Investment Digest. For more than 30 years, Successful Investing (formerly the Telephone Switch Newsletter) has produced double-digit annual gains. Doug has become known for his expert knowledge and timely use of innovative tools like Exchange Traded Funds, bear funds and Enhanced Index funds to profit in any market climate.

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