Why does Alan Greenspan believe that bond prices in the U.S. will dramatically d

Question

Why does Alan Greenspan believe that bond prices in the U.S. will dramatically decline during the next few years? Please be detailed. Thank You

https://www.cnbc.com/2017/08/04/ex-fed-chief-greenspans-new-bond-bubble-warning-feels-like-irrational-exuberance-deja-vu.html

As he's warning about a current bond bubble, former Federal Reserve Chairman Alan Greenspan told CNBC on Friday that it's fair to characterize it as an "irrational exuberance" type forecast.
The reference to "irrational exuberance" — the two words Greenspan is most famous for — hearkens back to remarks he delivered at a 1996 American Enterprise Institute dinner.
"What I was trying to say in the AEI speech … is you never can be quite sure when 'irrational exuberance' arises. I was doing it as part of a much broader speech, and talking about the analysis of markets," Greenspan said on "Squawk Box," reflecting on the investment environment of more than two decades ago.
"I wasn't trying to focus short-term. But the press loved that term," he added. "I am sort of now questioning whether it was wise to put it in the speech."
Greenspan said he's trying to ask similar questions in the current environment about when the three-decade bull market in bonds might end, considering "there's only one way" historically low interest rates can go and that's higher.
The Fed has signaled a willingness to increase rates further if the economy continues to cooperate. Central bankers have hiked the cost of borrowing money four times since December 2015, including twice this year alone.
In September 2007, as the financial crisis was heating up, the Fed began incrementally cutting rates and continued until December 2008, when the central bank's benchmark rate bottomed out at a range of zero to 0.25 percent where it stayed for seven years.
In December 2008, hoping to boost the economy, Fed officials also embarked on a series of bond-buying programs, which eventually swelled the Fed's balance sheet to the current $4.5 trillion. Only now is the Fed talking about how to wind down its portfolio of assets.
In making his forecast on bonds, Greenspan said Friday he's learned from the past. "It's a disturbing process because you have to be terribly careful with your words," he added, stressing he's not putting any time frame on it.
The 91-year-old Greenspan's tenure as Fed chairman spanned four presidents and nearly 19 years — starting with his appointment in 1987 by Ronald Reagan and ending with his retirement in 2006, after then-President George W. Bush tapped Ben Bernanke to lead the central bank. Bernanke was succeeded by current Fed Chair Janet Yellen in 2014.

Explanation / Answer

If we look at the boom and bust cycles in different asset classes, the long boom and bear periods generally last for 20-years.

As Mr. Greenspan points out, the current bull market in US bonds is already 3-decades old. In other words, the bull market has been extended. Interest rates in the US peaked out in 1981 and the trend has been lower ever since.

However, there are several factors that are likely to support the reversal in trend and an end to the long-term bull market in US bonds. They are as follows:

1) Inflation in the US has been accelerating and as growth stabilizes, it is likely that bond yields move higher and bond prices decline. It is worth noting that real interest rates in the US is still negative and this calls for further increase in bond yields (decline in bond prices).

2) There is a glut of liquidity in the global financial system after the crisis of 2008-09. While US has been tightening monetary policies, negative real interest rates still indicate expansionary policies in a subtle way. This excess liquidity in the financial system is likely to manifest itself in the form of asset inflation. It is expected that as energy and commodity prices trend higher, bond prices will decline on increase in bond yields.

3) After the global financial crisis of 2008-09, there has been a rush towards government bonds and that has resulted in decline in yields. However, with ample liquidity in the global financial system, low credit market risk and stable economic growth, it is expected money to flow out of risk free assets to risky assets in search of higher returns. This is likely to translate into lower bond prices and higher yields.

4) Geo-political tensions and trade war between US and China can potentially impact bond yields. In the past, China has been the largest buyer of US bonds. That will continue to change in the coming years and as demand for US bonds declines, there is a likely increase in yields.

5) US has significant amount of unfunded liabilities and federal spending is also likely to result in budget deficits in the coming years. This implies steady increase in outstanding government bonds. As US debt-to-GDP continues to increase in the long-term, it is entirely likely that bond holders will ask for higher returns. The markets are already demanding higher returns on US bonds and considering that the fed just follows the markets in increasing or lowering interest rates. With a likely uptrend in interest rates, bond yields will increase and bond prices are likely to decline.

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