Bonds' collapse 'threat to shares'

CONCERNS are rising that the recent worldwide collapse in the bond market could soon spill over into shares.

Falling bonds means higher borrowing costs, and long-term rates have soared since mid-June on sudden fears of inflation. US Treasuries have dropped by up to 20%. Here, markets predict rates will rise to 4.5% next year from 3.5%.

The predictions may well be wrong. But the surge in US long-term borrowing costs has choked off mortgage refinancing, imperilling the economic recovery. 'The last time this happened, in early 2002, consumer spending slowed dramatically and equity markets had a tough time,' warns Bijal Shah, strategist at SG Securities.

The bond rout has also raised fears of a 1998-style financial crisis when hedge fund Long-Term Capital Management collapsed. 'There has been a lot of distressed selling,' says Merrill Lynch strategist David Bowers. 'Someone is on the wrong side of this. Either the risk is spread around, or it is concentrated in one house as in 1998.'

He says it is 'surprising' shares have not yet reflected the rising risks. 'Many of our equity clients are starting to look over their shoulders.'

A hedge fund crisis cannot be ruled out. Sentiment is pressuring shares in well-established finance houses with bond exposure, such as Bear Stearns, Lehman Brothers and US mortgage banks Freddie Mac and Fannie Mae, although there is no suggestion they are in any trouble.