Credit Market Warning

There are large signs of stress now present in the credit markets. You might not know it from today’s multi-generationally low interest rates, but other key measures such as liquidity and volatility are flashing worrying signs.

Look, we all know that this centrally planned experiment forcing financial assets ever higher is simply fostering multiple bubbles, each in search of a pin. As all bubbles do, they are going to end with bang.

I keep my eyes on the credit markets because that’s where the real trouble is brewing.

Rising Yields

Let’s begin with the first canary in this story, rising yields. The yield of a bond, expressed as a rate of interest, moves oppositely to its price. The higher the price goes, the lower the yield goes. The lower the price, the higher the yield. Imagine the relationship like a playground see-saw.

Over these past few weeks and months, we’ve seen yields moving up quite a lot across a wide variety of bonds, at least in terms of the percentage size of the move (yes, the yields are still historically low by any measure).

Again, not everybody thinks this is ominous. Some think it’s a healthy sign that growth, as well as a “healthy” return to inflation, is on the way:

Interest rate climb brings out optimists

Part of the reason for the optimism is that rising rates are a healthy sign: They mean that U.S. and European economies are strengthening, people are spending, companies are hiring and prices are starting to rise at more normal rates. The risk of too-low inflation — which typically slows spending and makes loan repayments costlier — has receded.


However it’s not entirely clear that these rising rates have anything to do with better economic prospects or higher inflation.

Why?  The world’s markets have been primarily driven by liquidity flows.  The headwaters of that river are the easy money policies of the world’s central banks.  From there, the river picks up steam as corporations issue debt to buy back their shares.  Adding gasoline to the fire, margin loans are extended, and speculators lever up to chase assets world-wide.

Add it all up, and fundamentals don’t really matter at times like these. The huge flood of money and credit swamps everything.

Which means that the signals themselves become the news. And at this time, the direction of the tide of this money/credit flow is the signal that matters most.

And what is it telling us. That money is now beginning to move out of the credit markets. This is a huge development.

I’ll go further and say it is not just retirees’ security that is at stake, but much more than that. Our financial markets may simply stop working when this “mother of all bubbles” — comprising both equities and bonds — finally bursts.

Given the much greater size of money and credit that will be desperate to find an exit, and the lack of remaining options the central bankers have now versus then, the 2008 crisis may look tame in comparison.

Full article: Credit Market Warning (Peak Prosperity)

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