Federal Reserve Chair Janet Yellen, surveying the financial landscape for signs of bubbles after more than six years of near-zero rates, warned that both stocks and bonds are richly valued.

“I would highlight that equity-market valuations at this point generally are quite high,” Yellen said in Washington on Wednesday in response to a question at a forum on finance. “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

Yellen said bond yields “could see a sharp jump” when the Fed raises its benchmark interest rate. Most Fed officials predict that will happen this year for the first time since 2006.

The prospect of an adverse market reaction could make the Fed wary about raising rates too soon and too rapidly, said Thomas Costerg, an economist at Standard Chartered Plc in New York.

And:

Yellen said that after holding rates near zero since December 2008, the Fed must be on the lookout for threats to financial stability. She spoke in response to questions from International Monetary Fund Managing Director Christine Lagarde during a panel discussion at the “Finance & Society” conference sponsored by the Institute for New Economic Thinking.

She said she sees signs of “reach for yield” in the market for leveraged loans, and that bond yields could jump when the central bank raises its benchmark rate.

“Long-term interest rates are at very low levels,” Yellen said. “We could see a sharp jump in long-term rates” after liftoff.

“We saw this in the case of the taper tantrum in 2013, where there was a very sharp upward movement in rates,” she said in reference to the episode in the middle of that year, when then-Chairman Ben S. Bernanke suggested that the Fed could start tapering its bond purchases in the next few meetings.

David Fuller's view

What is the single word that springs to mind when someone asks you to describe a 35-year bull market?

Yes, I agree, it is BUBBLE!

Institutional investors have been buying US Treasuries for over three decades, wisely because inflationary pressures were coming down.  They received an additional fillip from QE.  However, is it still appropriate to refer to “safe assets like bonds”, as Dr Yellen does above?  Not in this context, I suggest. 

(See also yesterday’s ‘Interesting charts of the day.)   

I feel like the little boy calling wolf in talking about the end of the bond bull market, in terms of falling yields.  However, we are closer than ever to the point where investors in bond markets start to lose their nerve.  This started in 2009 for 30-Year T-Bonds with a sharp rally from approximately 2.5% to 4.8%, before Ben Bernanke reassured them with QE.  The next significant wobble commenced in mid-2012 and from the same region near 2.5% but only rallied to 4% as QE continued.  The current rally commenced in February from January’s low near 2.2%.  We are now at 3% and the Fed is very unlikely to resume QE in this cycle, in my opinion.  I think we are heading to at least 4% and I do not expect to see this year’s low again.

Stock markets are nervous and prone to periodic corrections.  Nevertheless, I believe they are a much better investment than bonds today. 

(See also yesterday’s Interesting charts of the day.)