Has The Fed Miscalculated, AGAIN??
The recent about-face in US Treasury rates is nothing short of stunning. Or is it?
At the end of 2015, Janet Yellen’s Federal Reserve first began the process of unwinding the prior years of stimulus. The key “Federal Funds” rate target was hiked a full five times. Even so, as incoming Chairman Jerome Powell was sworn in last February, the target was still only 1.25-1.50%.
The Dow Jones Industrial Average (Dow) had just made yet another all-time high at about 27,000. Reported economic data was practically “too good to be true”. Record low unemployment, rising wages and accelerating economic growth were reported daily. Powell’s biggest concern was that the years of ultra-low rates cause inflation.
The new Fed policy was to raise rates 4 times in 2018 and 3 more in 2019. If effectuated, the Fed Funds target would then reach 3-3.25%. By historical standards, that rate would STILL be quite low.
On October 3rd, Chairman Powell opined that short term rates were still a “long way” from “neutrality”. (Most economists believe “neutrality” is in the 3-3.5% range). (https://www.cnbc.com/2018/10/03/powell-says-were-a-long-way-from-neutral-on-interest-rates.html). This statement was consistent with Fed policy.
Powell’s tune soon changed, however, seemingly out of the blue. Last week, Powell stunned investors by saying that rates were “just below” neutral. Those two words signaled a full reverse. But Powell was merely following the market, which by then was in full retreat. “Interest Rates in Sudden, Full Reverse” (https://markonomics101.com/2018/12/02/interest-rates-in-sudden-full-reverse/).
Interest Rates Collapse Accelerating
The Slide Show below contains the last year’s history for 5, 10 and 30 year maturities. Ironically, they peaked at the same time Powell was justifying the need for further hikes. TLT, is the ETF for the 20 year Treasury. Keep in mind that yields and prices are inversely related.
Banks and Other Financials Under Extreme Pressure
The Federal Reserve controls short term rates, such as Fed Funds directly. One can think of Fed Funds as the wholesale lending cost for commercial banks. A lower Funds rate makes lending more profitable.
Banks make money by borrowing at lower short-term rates and lending at higher long-term rates. Lending creates business and economic expansion.
The Fed’s ability to influence longer term rates, however is indirect. Central Banks affect those through Open Market purchases and sales.
The financial sector is taking the brunt of higher rates. Citigroup (C) is ALREADY warning that this quarter’s revenues will be lower year over year (https://www.zerohedge.com/news/2018-12-05/citi-warns-q4-market-revenue-will-unexpectedly-shrink-last-year).
General Electric, once valued at $400 Billion, now trades for a mere $7. GE’s problems largely arise from GE Capital, its financial arm. With listed assets of nearly “$500 Billion”, GE Capital is larger than US Bancorp (USB) and American Express (AXP) (http://www.bankingexchange.com/images/Dev_SNL/6415BanksAssets.pdf).
However, several firms, including Bank of America, value GE’s financial arm at “ZERO” (https://www.cnbc.com/2018/04/12/bank-of-america-merrill-lynch-ge-capital-has-zero-equity-value.html).
What if GE Capital is worth LESS than ZERO? As far as GE’s shareholders go, a bankruptcy of the financial subsidiary may not directly affect the parent. But what about GE Capital’s counterparts? Anyone remember 2008?
Financials are the official downside leaders. The Slideshow below illustrates some of the “BLUE CHIP” names affected already.
Negative Interest Rates Around the World
The table below lists the yields for debt by country and maturity as of this morning and from figures supplied by CNBC (http://www.cnbc.com).
Country 3M T-Bills 2 Years 5 Years 10 Years 30 Years
United States 2.42% 2.80% 2.79% 2.91% 3.17%
United Kingdom 0.77% 0.75% 0.90% 1.31% 1.92%
Germany n/a -0.63% -0.27% 0.28% 0.93%
Italy n/a 0.58% 2.07% 3.08% 3.73%
France n/a -0.45% 0.01% 0.68% 1.62%
Japan -0.26% -0.13% -0.12% 0.07% 0.79%
Canada 1.67% 2.05% 2.08% n/a 2.26%
Negative interest rates? Really?
Since about 2015, interest rates in many countries in Europe have gone negative. It doesn’t seem even possible or logical, but it is.
Negative Rates Are Not Necessarily Abnormal
At the height of ZIRP (in 2016), it was estimated that 30% of all Global Government Bond Debt traded with negative yields. Today, it’s less, but still estimated at $7.3 Trillion (https://www.investopedia.com/terms/n/negative-bond-yield.asp).
Negative bond yields are similar to paying your local Bank a fee to safeguard your money. Bonds are priced in the country’s currency. An investor can absorb a small negative yield if the currency appreciates.
With the sole exception of Italian 10 and 30 year Bonds, interest rates in the United States are the highest of the developed world at every maturity. Given the global choice of risk and returns available to institutional Bond investors, the demand for US debt at what seems like ridiculously low interest rates becomes much easier to understand.
More Than Just Financials In Distress
Clues that economic activity has “gone off a cliff” are mounting. One is the sudden free fall in Crude Oil prices from $77 to below $50/bbl in a mere 6 weeks. “Crashing Crude Oil Prices A Sign of Oncoming Recession?” (https://markonomics101.com/2018/11/18/crashing-crude-oil-prices-a-sign-of-oncoming-recession/).
Automakers are stalling. While General Motors is moving plants offshore and drawing the ire of Congress, Ford is expected to lay off 25,000 people (https://www.zerohedge.com/news/2018-12-03/ford-could-cut-25000-jobs-during-planned-restructuring).
Homebuilders, too, are experiencing a pronounced slowdown. Toll Brothers recently blamed higher interest rates for the substantial drop in new home sales (https://www.marketwatch.com/story/home-builder-stocks-sink-after-toll-brothers-blames-rising-rates-negative-media-for-further-market-slowdown-2018-12-04).
Is Gold Firming As A Financial Crisis Hedge?
While it may be premature, GLD is worth keeping an eye on. Not only is inflation not visible but the Dollar is unusually strong. Gold’s newfound strength is possibly the result of “financial crisis fear”.
GLD’s price behavior of late is notable because it deviates greatly from recent history. While historically a great “crisis hedge”, Gold has been MIA for more than a decade. Precious Metals are so out of favor that they are set up perfectly for an upward run.
Time to Get Prepared Is Running Out
Financial Panics never arise at a convenient time. Most investors fail to either act or are just plain fooled by Mr. Market’s partner: Miss Direction. If you haven’t done so already, our guide to preparing yourself for the coming BEAR MARKET would be a good place to start. “How To Survive and Prosper In The Coming Bear Market (Part 1) (https://markonomics101.com/2018/10/09/how-to-survive-prosper-and-thrive-in-the-coming-bear-market-part-1/).
The best way of course to protect yourself is to “BE INFORMED, NOT MISLED”
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