For several months various economists have warned of the increasing danger of another potential bubble being burst, one that could have serious repercussions for the US and global economy. The latest man to reinforce those so far ignored warnings is Jeremy Stein one of the governors at the Federal Reserve.
Speaking in St Louis last Thursday, Stein spoke of his concern about ‘a fairly significant pattern of reaching-for-yield behaviour emerging in corporate credit’. In the first 11 months of 2012, companies purchased a massive $324 billion worth of junk bonds meaning that in December of 2012 the speculative bond bubble was more than double the size of any of the other bubbles that burst before the 2007-2008 financial crash. Now that we’re in February 2013 that figure has increased even further.
Stein as a member of the Federal Open Markets Committee has a vote on whether the Fed should attempt to pop the bubble before the risks get any higher. The Federal Reserve has played a big part in the build-up of the bubble as it has built up an unprecedented portfolio of bonds worth $3 trillion.
Investors are expecting the Fed to keep adding to that portfolio and to keep inflating the bubble for up to another year. Any hint that the Fed may hit the brakes sooner than that could cause a sharp rise in bond yields, in anticipation that the central bank may eventually begin selling bonds. Too sharp a rise could bring lending to a halt and throw the economy back into a recession.
The junk bond bubble is just one of a number of potential financial and economic dangers facing the US. President Obama is already set to tackle the issue of the debt ceiling later this month as well as a return over the fiscal cliff debate (which was only temporarily delayed in January) and the unresolved issue of the Federal budget.
The junk bond bubble is a threat but one that is likely to emerge at some point in the future, first the US has to navigate all of those other challenges. If the junk bond bubble bursts it could however prove to be the next economic crisis in the making.
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