Cat on a
Hot Tin Roof – Some Explanations and Information
A cat on a hot tin roof is the appropriate image for how the
financial markets and economies feel and are reacting at the moment. An
avalanche of commentaries and volumes of data are pouring into and being poured
over by a myrid of individuals, specialists, talking heads, and governmental
bodies. There is no shortage of information, opinion, comment, commentary,
noise and confusion. I have found a couple of articles over the past 2 weeks I
think may be interesting and helpful. I am including them in their entirety.
Some observations. Quoting from the first line of the
Bloomberg article, “The world’s most powerful central bank is about to find out
how far it can squeeze financial markets before something breaks.” That sums up
exactly what is happening. That is the 900 lbs. gorilla in the room. If or when
it breaks, that is recession. The 2nd article from the Spokane
Review (originally from Bankrate.com) is a pretty good discussion on how rising
interest rates may impact various financial instruments. Remember, don’t focus
on the hype language. Look for the solid information. Good luck. Hang in there
and don’t panic.
https://www.bloomberg.com/graphics/2022-world-economy-wall-street-market-worries/
Bloomberg
Everything That Could Go Wrong in Markets as Free-Money
Era Ends
By Jack Pitcher, Alexandra Harris, and Alex McIntyre
May 9, 2022, 6:00 AM MDT
The world’s most powerful central bank is about to find out
how far it can squeeze financial markets before something breaks. Struggling to
tamp down the most pervasive inflation in decades, the Federal Reserve
delivered its biggest interest-rate increase since 2000 last week while outlining
a plan to begin unwinding trillions of dollars in asset purchases that have
kept world markets brimming with cash since the 2020 crash. Its peers will soon
follow suit. Bloomberg Economics has estimated that policy makers in the Group
of Seven countries from the European Central Bank to the Bank of Canada will
shrink balance sheets by about $410 billion combined in the remainder of 2022.
Yet it all comes at one of the most precarious times in
recent memory for the global economy. Russia’s war in Ukraine, and the bevy of
sanctions that followed, have upended business. Supply chains that were
disrupted by the pandemic have grown even tighter, causing chaos for companies
lashed by soaring prices for everything from labor to commodities. The worry
now is whether central banks can accomplish the high-wire act of weaning Wall
Street off unprecedented stimulus, without disrupting the flow of capital and
tipping economies into recession.
Bloomberg News canvassed traders, money managers and
analysts on their top market indicators to track corporate distress, liquidity
shocks and cracks in the financial plumbing. We then analyzed decades of price
history to identify the systemic turning points — when central bankers on a
hawkish mission risk crashing the real economy.
While there’s little sign of widespread stress yet, some
barometers of cross-asset health are moving closer to the danger zone. All that
suggests investors are in for a bumpy ride as the Fed drains its unprecedented
liquidity measures.
Here are four indicators keeping Wall Street worrywarts on
edge.
1. An Upside-Down Bond Market
Like it or not, the U.S. Treasury yield curve remains the
top dog economic forecaster on Wall Street — even if the Fed’s bond-buying
spree in the pandemic has distorted its message. In normal times, when the
business cycle is in good health, the interest rate on debt maturing in, say,
10 years, will be higher than that on shorter-term securities as investors
demand more compensation for the risk that inflation down the road will erode
returns. If the opposite happens, meaning short-term rates are higher than the
longer term, the foreboding dynamic is known as an inversion — signaling a bet
that the central bank will eventually have to cut rates in order to salvage
growth.
While not every inversion in the yield curve has led to a
downturn, prolonged distortions have become eerily accurate, especially when
two of the most widely followed curves become inverted at the same time, data
compiled by Bloomberg show. Since the beginning of the 1990s, whenever yields
on both 3-month Treasury bills and two-year notes have risen above the rate on
10-year bonds, a recession has followed almost without fail within the next six
to 18 months. It's a simplified measure — the most recent double inversion
preceded a pandemic that no one saw coming — but big moves in yield curves have
kept Wall Street on edge recently.
In late March and the start of April, the gap between two-
and 10-year yields briefly inverted before normalizing, reflecting market angst
that the Fed’s mission to aggressively tighten policy risks sparking a
recession by ramping up the cost of money and thereby constraining consumer
spending as well as business activity. At the same time, the spread between the
three-month Treasury bill and the 10-year yield has been heading in the
opposite direction, suggesting a still-healthy outlook for U.S. investment and
consumption that gives the central bank room to make good on its
policy-tightening plan.
For now, yield-curve worriers are easy to find as the end of
the easy-money era rocks global markets. Already this year, the Nasdaq 100
index of technology shares has had the worst start in decades, speculative
stock strategies have lost billions and cross-asset volatility has spiked all
over the world.
PGIM Chief Executive Officer David Hunt warned last week
that signals in the bond market suggest a significant risk of a recession in
2024, while Citadel’s Ken Griffin said the outlook is the most uncertain since
the global financial crisis.
2. Disruption to the Flow of Credit
U.S. companies have lost their ability to borrow money at
ultra-cheap rates, a direct function of the Fed’s mission to cool the red-hot
business cycle that’s stoked inflation for everything, everywhere all at once.
But when borrowing costs surge too far, too fast, the flow
of corporate credit can become disrupted or even blocked entirely. In extreme
instances, healthy companies can lose access to funding, wreaking economic
havoc. This happened most recently during the onset of the pandemic, which
forced the Fed to take unprecedented action to keep corporate America afloat.
The most widely followed credit gauge is the additional
yield over Treasury bonds that investors demand to hold debt from the largest
and strongest U.S. corporations. Currently, the spread on a Bloomberg index of
U.S. investment-grade bonds has risen to 1.35 percentage points, from as low as
0.8 percentage point in June 2021, signaling higher borrowing costs that still
sit below a key threshold for stress.
When the spread rises above 1.5 percentage points, it’s a
warning sign that credit markets could seize up, making borrowing a lot harder,
according to analysts and investors informally polled by Bloomberg. The metric
has proved a reliable red flag in the past after crossing 2 percentage points
in the volatile years after the global financial crisis and during the pandemic
fallout.
To illustrate how the flow of credit across the entire U.S.
economy can constrict, Bloomberg examined commercial and industrial loan data
from all commercial banks, published monthly by the Federal Reserve.
The analysis, dating back to 1989, shows that when
investment-grade credit spreads approach and exceed 2 percentage points, a
threshold that’s been crossed just six times over that period, a contraction in
loan growth almost always follows.
In January 2008, for example, borrowing costs for
investment-grade companies soared to more than 2 percentage points for the
first time in more than five years. Risk premiums remained above that level for
nearly two years, and a prolonged slowdown in commercial and industrial loan
volumes came next. Loan volumes fell for two years beginning in November 2008,
causing historic damage to the world economy.
More recently, credit spreads spiked to over 3.5 percentage
points in the March 2020 selloff. Yet some of the easiest borrowing conditions
on record took hold in the following year as the Fed pumped liquidity into the
financial system and even offered to buy corporate bonds directly.
Now premiums are back on the rise and company debt is
becoming volatile. Investors and companies alike will be watching whether
borrowing costs spike into risky territory that would disrupt the flow of
credit once more.
3. The Junk Penalty
Borrowers with weak balance sheets were given a reprieve
after the Fed and other central banks rode to the rescue in the dark days of
the pandemic. For the better part of two years, credit was dirt cheap and
defaults became virtually non-existent. But the liquidity party is coming to a
rapid end as interest rates rise — with new speculative-rated debt offerings
this year falling to the lowest volume since 2009.
A recent bond sale from Carvana Co., for example, initially
struggled to attract investors, and the used-car company ended up paying a
whopping 10.25% yield while buyers demanded a clause intended to help shield
them from losses if the company were to head to bankruptcy court. Similar cases
abound.
A measure investors are watching closely is the extra risk
premium that bond buyers demand to own debt from the lowest-rated companies
compared to investment-grade peers. Call it the junk-bond penalty. When this
premium goes up, it makes borrowing more costly and less accessible to issuers
who need the funding the most, especially those who have poor credit ratings
due to weak cash flows or high debt loads compared to their earnings.
If firms that have limited money on reserve and debt coming
due in the near future lose access to primary markets, that makes defaults and
bankruptcies more likely — bad news for growth-minded policy makers at the
White House.
For most of the post-pandemic era, junk-rated companies
across the globe paid little more to borrow than some of the biggest
corporations — an average of just 2.4 percentage points more during 2021, a
year that saw some of the easiest credit conditions ever, according to data
compiled by Bloomberg. That made corporate failures exceptionally rare. But the
tide is starting to turn. The junk penalty climbed above 3 percentage points
last week. While that’s below the historical average of about 4 percentage
points, the fast pace of liquidity tightening could soon cause trouble for the
most vulnerable of companies. Since 2000, when the junk penalty has climbed
above 5 percentage points and held above that level for an extended period,
defaults have almost always risen above the historic norm, data compiled by
Bloomberg show.
4. Short–term money markets crack
The Fed’s massive pandemic stimulus program caused excess
liquidity in the financial system to balloon, with banks flush with record cash
in the form of reserves. Now, as the monetary authority begins to pare a $9
trillion balance sheet, a process known as quantitative tightening, Wall Street
is on high alert for any resulting logjams in the financial plumbing.
When the Fed starts to shrink asset holdings — by simply not
replacing maturing securities — there will be an increase in the number of
Treasuries and mortgage bonds in search of a home in the private sector. And
the amount of reserves held in the banking system will fall by design.
No one knows how any of this will ultimately play out. But
the last time the central bank embarked on quantitative tightening, bad things
eventually happened in late 2019. Banks saw their reserves fall sharply —
fueling a disruptive spike in interest rates on so-called repurchase
agreements, a keystone of short-term funding markets. That caused liquidity
headaches all around and forced the central bank to intervene in the funding
markets.
The Fed has since implemented additional tools to help
reduce these liquidity risks. But all bets are off. Some two and half years
ago, total reserves held by depository institutions at the Fed slid to around
$1.4 trillion. That was enough to cause liquidity issues in overnight lending,
even though banks at the time considered $700 billion as the lowest threshold
for comfort.
This time round, Barclays Plc estimates the tipping point at
some $2 trillion versus $3.3 trillion currently. All this is guesswork with few
historic precedents, so the reserve level will be a key focus for risk watchers
well before it hits this point.
All in, traders around the world are bracing for a
disruptive tightening in financial conditions on multiple fronts, from bonds
and credit to money markets, as the Fed spoonfeeds markets with liquidity no
longer.
“We have never been able to reduce inflation by more than 2
percentage points in the U.S. historically without inducing recession,” said
Guggenheim Partners Chief Investment Officer Scott Minerd at the Milken
Institute Global Conference in Los Angeles. “I think that it's going to be
really hard for the Fed to maneuver into a soft landing.”
https://www.spokesman.com/stories/2022/may/09/biggest-winners-and-losers-from-the-feds-interest-/
The Spokesman Review - Spokane, Washington
Biggest winners and losers from the Fed's interest rate hike
Updated: Mon, May 9, 2022
Spokane, Washington
James Royal Bankrate.com
(TNS)
Last week, the Federal Reserve announced that it’s raising
interest rates by half a percentage point, bumping the federal funds rate to a
target range of 0.75 to 1.00 percent. The move follows an increase of 0.25 percent
in March, as the Fed continues reducing liquidity to the financial markets to
help tamp down soaring inflation.
The central bank also announced that it was further reducing
stimulus to financial markets by letting its holdings of bonds decline over time.
The Fed will work its way up to letting about $95 billion in bonds roll off its
balance sheet every month, reducing liquidity by about $1 trillion per year.
The Fed’s move comes as inflation rages in the U.S. economy
at the highest annual rate in some 40 years, hitting 8.5 percent in March. With
the Fed hitting the brakes on an overheated economy, the main question for many
market watchers is how fast Federal Reserve Chairman Jerome Powell & Co.
will continue to raise rates.
“The Federal Reserve is behind the curve on inflation and
has a lot of catching up to do,” says Greg McBride, CFA, Bankrate chief
financial analyst. “This means rate hikes at successive meetings for the first
time in 16 years, and for the first time in 22 years, a larger half-point
hike.”
At about 3 percent, the 10-year Treasury bond is now at its
highest level since late 2018, as markets price in the expectation of sustained
inflation and rising rates. After some ups and downs in 2021, the benchmark
bond has soared since December 2021 and especially since the start of March,
when it sat at just 1.65 percent.
As the Fed embarks on what appears to be a longer period of
raising rates, here are the winners and losers from its latest decision.
1. Mortgages
While the federal funds rate doesn’t really impact mortgage
rates, which depend largely on the 10-year Treasury yield, they’re often moving
the same way for similar reasons. With the 10-year Treasury yield zooming
higher in recent months, as the market prices in expectations of the Fed
raising rates, mortgage rates have risen alongside them.
“Mortgage rates have bounded higher by 2 full percentage
points since the end of 2021, one of the largest and fastest run-ups in
history,” says McBride. “Mortgage rates move well in advance of Fed action and
the outlook for inflation and the economy will be the key determinants of what
we see with mortgage rates in the months ahead. Until we see signs inflation
has peaked, the risk is definitely to the upside.”
The run-up in rates – following the rapid rise in housing
prices over the past couple years – has created a double whammy for potential
homebuyers. Home prices are more expensive and the financing is pricier,
resulting in a slowdown in the housing market.
So would-be homebuyers are worse off by the rise in rates.
2. Home equity
The cost of a home equity line of credit (HELOC) will be
ratcheting higher, since HELOCs adjust relatively quickly to changes in the
federal funds rate. HELOCs are typically linked to the prime rate, the interest
rate that banks charge their best customers.
Those with outstanding balances on their HELOC will see
rates tick up, though interest expenses may continue to be low historically. A
low rate is also beneficial for those looking to take out a HELOC, and it can
be a good time to comparison-shop for the best rate.
But with rates moving higher, even a little bit, and the
expectation that they’ll move higher still as the year progresses, those with
outstanding HELOC balances should expect to see their payments continue to rise
in the near term.
3. Credit cards
Many variable-rate credit cards change the rate they charge
customers based on the prime rate, which is closely related to the federal
funds rate. The Fed’s decision means that interest on variable-rate cards will
move higher now.
“Credit card rates will march higher in step with the
Federal Reserve, and often follow within one or two statement cycles,” says
McBride. “Pay down credit card debt now because it will only get more expensive
and you don’t want that debt hanging over your head, should the economy topple
into recession.”
If you have an outstanding balance on your cards, then
you’re going to get hit with higher costs. With rates projected to rise for a
while, it could also be a welcome opportunity to shop for a new credit card
with a more competitive rate.
Low rates on credit cards are largely a non-issue if you’re
not running a balance.
4. Savings accounts and CDs
Rising interest rates mean that banks will offer rising
returns on their savings and money market accounts, but will likely adjust
their yields at a measured pace.
Account holders who recently locked in CD rates will retain
those yields for the term of the CD, unless they’re willing to pay a penalty to
break it.
Those with savings accounts may look forward to rising
rates, but it’s off a low base, as most banks quickly ratcheted rates to near
zero following the Fed’s emergency cuts in March 2020.
“Yields on certificates of deposit have started to pick up
and we’ll see the same in savings yields, although with a bit of a lag,” says
McBride. “The outlook for the next year or so is much better than what savers
have endured over the past three years, where rates fell and then inflation
took off.”
“It will take a while, but as rate hikes continue, the returns
savers get will rise and inflation will hopefully decline,” he says.
Savers looking to maximize their earnings from interest
should turn to online banks, where rates are typically much better than those
offered by traditional banks.
5. Stock and cryptocurrency investors
A huge boon for the stock market has been the Fed’s
willingness to keep rates at near zero for an extended period of time. Low
rates have been beneficial for stocks, making them look like a more attractive
investment in comparison to rates on bonds and fixed income investments such as
CDs. But that’s changing.
In the last few months, investors have been pricing in the
potential for rate increases, with the S&P 500 starting 2022 in a deep
slump.
“The market went up with little hesitation while the Federal
Reserve was pumping stimulus into the economy, but now that they’re removing
that stimulus, market volatility has returned,” says McBride. “Particularly
susceptible have been the high-octane growth stocks that were the primary
beneficiaries of low interest rates, with investors now questioning what value
to put on those stocks in a higher interest-rate environment.”
Cryptocurrencies have also been feeling the brunt since
November, when the Fed more clearly telegraphed its intentions to reduce
liquidity in the financial system. Bitcoin, Ethereum and other major cryptos
are well off their 52-week highs and have shown a solid downtrend over the last
few months, as they priced in reduced stimulus and the potential for higher interest
rates.
The Fed’s reduction in its own bond portfolio should further
decrease support for stocks and crypto.
6. The U.S. federal government
With the national debt above $30 trillion, rising rates will
raise the costs of the federal government as it rolls over debt and borrows new
money. Of course, the government has benefited for decades from a secular
decline in interest rates. While rates might rise cyclically during an economic
boom, they’ve been moving steadily lower long term.
For now, the interest rates on debt remain at historically
attractive levels, with 10-year and 30-year Treasurys running well below
inflation. As long as inflation remains higher than interest rates, the
government is slowly taking advantage of inflation, paying down prior debts
with today’s less valuable dollars. That’s an attractive prospect for the
government, of course, but not for those who buy its debt.
Bottom line
Inflation has been running hot over much of the last year,
and the Fed is raising interest rates to combat it. But rates still do remain
low by historical standards, at least for now, so it makes sense to think about
how to take advantage, for example, by being more discriminating when it comes
to shopping for rates on your savings accounts or CDs.
(Visit Bankrate online at bankrate.com.)
©2022 Bankrate.com. Distributed by Tribune Content Agency,
LLC.
