Eurozone bond market akin to dotcom bubble?
There is a bubble in eurozone bonds similar to the dotcom bubble at the beginning of the century, a US-based economist warns
The problem with the dotcom shares back in 2000, when the bubble burst, was that investors realized that there was "no clear path to profitability and no clear path to sustainability," according to Carl Weinberg, chief economist at High Frequency Economics, a US-based economic research consultancy.
Nowadays, Germany is borrowing at rates lower than inflation and Italy is borrowing at the lowest cost it has ever seen, Weinberg pointed out in his daily notes on the global economy.
Lower-than-inflation yields are unlikely to attract investors forever, regardless how safe the bonds are, he said.
"At present low yields, investors may begin to wonder if the only direction market rates can go from here is up. This opens the door to interest rate risk for all but buy-and-hold investors," Weinberg added.
"The dotcom example suggests that sometimes market exuberance pushes prices so high that the only trade that makes sense is to sell ... so investors flee."
The similarity he sees with the dotcom bubble in Italy's case is that the country has "no clear path to fiscal sustainability" as the new government is committed to unwinding parts of the fiscal reforms put in place by technocrat prime minister Mario Monti.
In Weinberg's opinion, one scenario in which the eurozone bond bubble could burst would be if the Federal Reserve starts to "taper off its bond purchases," sending US long-term bond yields higher. The rising US yield curve would push up global yield curves, a move that would hit countries that cannot afford to pay higher borrowing costs without a crisis.
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As European stocks hit record highs, Weinberg said he felt that investors may be running to an "unsafe haven."
The high P/E ratios depend on sales projections and profit trajectories that the contracting eurozone economy may not be able to deliver, and "cash may well become the ultimate safe-haven destination," he warned.
"We cannot tell you when this will happen, but we think this feels like one of those times when no one will be able to act surprised when the wheels finally come off the bus," Weinberg wrote.
He expects cash to "flood out" of the eurozone, initially to North America pushing the dollar higher but ultimately to Asia, "where real returns on capital are achievable."
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