Recent warnings regarding dangers in the bond market were recently issued by bond maestro Bill Gross. These warnings are reminiscent of Alan Greenspan’s implicit warning in a 1996 speech when he asked: “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?” Specifically, Mr. Gross, co-manager of PIMCO, wrote: “Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is fragile.” Referring to the Fed policy of quantitative easing, which some say is creating an asset bubble, Mr. Gross wrote: “If and when the support dissipates or if the economy remains anemic, investors should be cautious and temper their enthusiasm.”
Mr. Gross further informed readers of his monthly investment newsletter that they should be cautious, because irrationality was already approximately 6 on a scale of 10 and rising. Moreover, one Fed Governor (Jeremy Stein) has recently expressed an opinion that corporate bonds showed signs of excessive risk taking (“Gross Says Corporate Bonds Irrationally Priced as Risks Rise,” by Liz Capo McCormick and Lisa Abramowicz, Bloomberg).
Fed policy makers are in public disagreement over the risk of financial instability that could flow from quantitative easing. Those who see a significant risk of financial instability are worried about investors and investment advisers “reaching for yield” – i.e. knowingly or (more likely) unknowingly taking on more risk to achieve higher yields in the bond market.
Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.