The U.S. bond market is heading for a crash according to a report from RBC Financial Group. With the U.S economy set to improve, the firm is warning about bond market overvaluation.

“It’s been said that bad news comes in threes and with two bubbles already gone or going — U.S. equity markets and the U.S. dollar — the bond market is primed to be the third,” cautions RBC economist Allan Seychuk.

“The three bubbles are not unrelated as soft equities have encouraged investors to chase yields across financial products as evidenced by spread compression in mortgage backed securities, corporate bonds, emerging market bonds and even in the absolute level of U.S. treasuries,” says Seychuk.

He adds that, despite the improving signs coming from the economic data, markets do not yet buy the idea that the economy has entered a period of sustainable recovery. However, je says the U.S. labour market will eventually improve, taking short-term rates higher.

“If investors wait until the Fed starts to point that out, the exit door will likely be spinning so fast most will not escape from the bond market unscathed,” he says.

RBC is forecasting a relatively gradual upward move in yields this year before a pick-up in 2004, with the 10-year Treasury yield expected to hit 4% by year-end.

http://www.rbc.com/economics/market/daily_e.html