And markets are totally unprepared
The financial markets have had a bit of a tough time going anywhere this year.
2015 stands in relative contrast to largely upward stock and bond market movement over the past three years. What’s different this year and what are the risks to investment outcomes ahead?
Higher Interest Rates Ahead
As I have suggested in recent discussions, the probabilities are very high the US Federal Reserve will raise interest rates this year. Yes, Ms. Yellen intimated it may come later, but remember she also canceled her appearance at the Fed’s annual Jackson Hole soiree this year, a meeting that takes place just a bit before the September Fed FOMC meeting. I think the markets are attempting to “price in” the first interest rate increase in close to a decade.
Importantly, we’re talking about the re-pricing of credit in the US financial system and economy broadly. We all know how important credit has been to underpinning the US economy for literally decades now. I believe this is a key part of the story of why markets are acting as they are in 2015. However, there are much larger longer term issues facing investors lurking well beyond the short term Fed interest rate increase to come: bond yields (interest rates) rest at generational lows and prices at generational highs – levels never seen before by investors. Let’s set the stage a bit, because the origins of this secular issue reach back over three decades.
The New Era Of Central Bank Panic
So it’s very important to note that over the last five months, we have witnessed the 10 year US Treasury yields move from 1.67% to 2.4%+, and the Fed never lifted a finger.
In Germany, the yield on a 10 year German Government Bund was roughly .05% a month ago. As you may know, the interim high was a few ticks above 1%. That’s a 20 fold increase in the ten year German Bund rate inside of a month’s time. Now that’s a liquid market! And you think this was lost on Central Bankers?
To the point, for a global market that has risen at least in part on the back of confidence in Central Bankers, this type of volatility we have seen in longer term global bond yields as of late implies investors may be concerned Central Bankers are starting to “lose control” of their respective bond markets.
Put another way, investors may be starting to lose confidence in Central Bank policies being further supportive of bond investments.
This is not a positive development in a cycle where this buildup of confidence has been such a meaningful support to financial asset prices in totality. If the investment community ever came to believe, even for a short time, that Central Banks had lost control of their respective bond markets, well… you haven’t even seen volatility yet.
As Go The Credit Markets, So Goes The World
Globally, the value of outstanding credit instruments is three times the total value of publicly traded equities. Just which do you imagine is more important to institutional investors?
As we think about the potential for global capital movements not only geographically, but also as movement among asset classes, all eyes should be on the global credit markets. So much capital is stored there that if it starts flowing out, and likely to the sidelines (i.e. safe havens), prices for everything are going to be impacted. And losses to today’s most commonly-held financial securities could be absolutely tremendous.
Full article: The Global Credit Market Is Now A Lit Powderkeg (Peak Prosperity)