The Global Credit Market Is Now A Lit Powderkeg And Markets Are Totally Unprepared

Greetings,

The Global Credit Market Is Now A Lit Powderkeg And Markets Are Totally Unprepared

BY IWB

by Brian Pretti

The financial markets have had a bit of a tough time going anywhere this year.

The S&P 500 has been caught in a 6% trading band all year, capped on the upside by a 3% gain and on the downside by a 3% price loss. It has been a back-and-forth flurry while the stock market up to this point has simply marked time.

We’ve seen a bit of the same in the bond market: after rising 3.5% in the first month of the year, the ten year Treasury bond has given away its year-to-date gains and then some.

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.

30 Years Of Lowering

It may seem hard to remember, but in September of 1981, the yield on the ten year US Treasury bond hit a monthly peak of 15.32%. At the time, Fed Chairman Paul Volcker was conquering long-simmering inflationary pressures in the US economy by hiking interest rates to levels no one alive had ever seen. 31 years later, in July of 2012, that same yield on 10 year Treasury bonds stood at 1.53%, a 90% decline in coupon yield, as Fed Chairman Bernanke was attempting to slay the perception of deflation with the lowest level of interest rates investors had ever experienced.

This 1981-to-present period encompasses one of the greatest bond bull markets in US history, and certainly over our lifetimes. Importantly, existing bond prices rise when interest rates fall, and vice versa. So from 1981 through the present, bond investors have been rewarded with coupon yield (ongoing cash flow) and rising prices (price appreciation via continually lower interest rates). Remember, this is what has already happened.

As always, what is most important to investors is not what happened yesterday, but rather what they believe will happen tomorrow. Although this is not about to occur instantaneously, the longer term direction of interest rates globally has only one road to travel – up. The key questions ultimately being, how fast and how high? Why is this important?…..more here

Social

The Global Credit Market Is Now A Lit Powderkeg And Markets Are Totally Unprepared