Bond Bubble Watch: How Low Can Yields Go?

Colin Barr at Fortune’s Street Sweep (an Observer Wall Street favorite) offers a balanced take on the where U.S. Treasuries might be headed following their meteoric rise in popularity in 2010.

Traders have flooded into the bond market at a rapid clip as concerns that the economy isn’t recovering fast enough — and may be headed for a double dip — have engendered a widespread flight from risk into the relative safety of government bonds and other high-grade debt securities. The ensuing rise in price has driven yields down. The benchmark 10-year Treasury note has gone from a high of around a 4 percent yield this spring to as low as 3.47 percent in August.

So is the bond buble ready to burst? Hard to say. On one hand, economic uncertainty makes U.S. Treasury securities seem like an attractive bet to investors, and it’s unlikely that the boom times will return any time soon. On the other hand, Barr writes:

But the case for Treasurys at current prices assumes a strong probability of deflation, a persistent decline in prices that damages the economy by increasing real debt burdens. Every piece of economic news that shows even minor improvement undermines that case and boosts the argument that bond yields should be higher.

So bonds are probably overpriced, but for the short term, “even if a big bond selloff isn’t at hand, coming weeks are likely to bring enough frantic trading and big price swings that it will be hard at times to tell the difference.”

That conclusion hardly supports a trading position, but we’re not sweating it. Swings in the market are bound to make for good copy in the near future, meaning highly opinionated financial firebrands are liable to continue saying wacky things about the market for government debt. Let’s have fun watching! Bond Bubble Watch: How Low Can Yields Go?