The question comes up whenever anyone knowledgeable is asked about the markets: Are we in a bubble? It is almost always about the stock market, which has reached record levels lately despite all the unsettling news. Hardly anyone ever asks about the bond market—but a bond bubble could be far more dangerous than an equity bubble.
It may seem an odd moment for this question, given that nominal yields on 10-year U.S. Treasury bonds topped 4.3% last week. That’s high relative to recent history, but it’s low considering another government figure released last week: 100.2%, which is the U.S. debt-to-GDP ratio as of March 31. That means America’s public debt is now greater than the size of its economy. The debt-to-GDP ratio is expected to reach 107% by 2030, exceeding the postwar high of 106% in 1946.
And yet, while rates have been elevated since inflation returned and sometimes go up with news of tariffs or higher oil prices, a yield of 4.3% amounts to about 2% after expected inflation. In other words: This is not a market worried about debt. And to be fair, people have been sounding these warnings for years (ahem, myself included) and nothing has happened. Debt has gone up and yields have gone down.
One reason that yields aren’t higher may be that markets expect more rate cuts this year, especially with Kevin Warsh taking over as chair of the Federal Reserve. Or maybe bond markets, like stock markets, have AI fever. There is an argument that AI will transform the economy and increase government revenue faster than the government can increase spending, which will reduce the debt and cause rates to fall.
There is also a popular notion that bond traders can see the future, that they know what inflation will be or if a recession is coming. But bond markets are often wrong. And they may be wrong now because bond yields are low relative to the risks the economy faces.
It’s not just the uncertain inflation outlook, with higher oil prices, reduced trade and a more dovish Fed. The bigger long-term concern, the one that worries JPMorgan CEO Jamie Dimon, is the huge debt bomb coming for the U.S. as its population ages. There is a low risk of outright default, but it will be tempting for the Fed to inflate away debt or monetize it through quantitative easing. And with an aging population, the U.S. can’t count on domestic buyers for its debt. The only hope is that foreign buyers will make up the difference, as they have in the past.
In the 2000s and 2010s, foreign central banks were reliable buyers of U.S. Treasuries; they needed to manage their own currencies, and Treasuries were the world’s safe asset. But demand fell after inflation and tariffs returned. So far, foreign private investors have picked up the slack, but their motives are different.
Bond buyers used to be willing to pay higher prices for U.S. Treasuries, and accept lower interest rates, because they wanted the liquidity and relative security that only Treasuries could provide. The difference between Treasuries and other bonds was known as the “convenience yield”—basically, the premium paid to the U.S. government for liquidity, safety and reliability. Economists estimate that this yield has already shrunk and could be near zero. The falling convenience yield means the U.S. market is much less special; investors today are seeking returns, not safety.
Another fading advantage for the U.S. bond market is sheer size. In the past, if you wanted to buy lots of bonds, there was nowhere else to go. Now, as Europe increases its spending on both defense and care for its aging population, it will issue more debt—creating more competition for bond sellers. To attract buyers, countries will have to raise rates. For U.S. Treasuries, it all adds up to more supply, less demand and less pricing power.
Which raises the question: So why are nominal yields at just 4.3%? One answer may be that bond markets are ignoring macro trends, but even for them this is a big one to miss. Maybe they are counting on AI, but if so bond markets are banking on an even bigger productivity boost than equity markets are, which are already pretty optimistic.
Overpriced bonds should worry people much more than an equity bubble. A drop in bond prices has the effect of repricing risk throughout the economy, causing disruptions everywhere. U.S. Treasuries are the foundation on which risk is priced, so if their yields rise—so do stock prices and corporate yields. And if corporations and borrowers can no longer repay their loans, mortgage rates go up, and banks face liquidity issues. Private equity would have its long-awaited reckoning.
Even at yields of more than 4%, Treasuries aren’t offering much relative to the risks they pose. All the same, to return to the question I started with: I have too much faith in efficient markets to believe in bubbles, because calling them requires knowing when they will pop. And for Treasuries, no one knows when that will be.
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.
This article was provided by Bloomberg News.