Tag Archives: interest rates

Living Dangerously, by Alasdair Macleod

Suppressing interest rates, encouraging debt, and discouraging savings generally does not end well. From Alasdair Macleod at goldmoney.com:

Regular readers of Goldmoney’s Insights should be aware by now that the cycle of business activity is fuelled by monetary policy, and that the periodic booms and slumps experienced since monetary policy has been used in an attempt to manage economic outcomes are the result of monetary policy itself. The link between interest rate suppression in the early stages of the credit cycle, the creation of malinvestments and the subsequent debt dénouement was summed up in Hayek’s illustration of a triangle, which I covered in an earlier article.[i]

Since Hayek’s time, monetary policy, particularly in America, has evolved away from targeting production and discouraging savings by suppressing interest rates, towards encouraging consumption through expanding consumer finance. American consumers are living beyond their means and have commonly depleted all their liquid savings. But given the variations in the cost of consumer finance (between 0% car loans and 20% credit card and overdraft rates), consumers are generally insensitive to changes in interest rates.

Therefore, despite the rise of consumer finance, we can still regard Hayek’s triangle as illustrating the driving force behind the credit cycle, and the unsustainable excesses of unprofitable debt created by suppressing interest rates as the reason monetary policy always leads to an economic crisis. The chart below shows we could be living dangerously close to another tipping point, whereby the rises in the Fed Funds Rate (FFR) might be about to trigger a new credit and economic crisis.

 

living danger 1

Previous peaks in the FFR coincided with the onset of economic downturns, because they exposed unsustainable business models. On the basis of simple extrapolation, the area between the two dotted lines, which roughly join these peaks, is where the current FFR cycle can be expected to peak. It is currently standing at about 2% after yesterday’s increase, and the Fed expects the FFR to average 3.1% in 2019. The chart tells us the Fed is already living dangerously with yesterday’s hike, and further rises will all but guarantee a credit crisis.

The reason successive interest rate peaks have been on a declining trend is bound up in the rising level of outstanding debt and loans, shown by the red line on the chart. Besides a temporary slowdown during the last credit crisis, debt has been increasing over every cycle. Instead of sequential credit crises eliminating malinvestments, it is clear the Fed has prevented debt liquidation for at least the last forty years. The accumulation of debt since the 1980s is behind the reason for the decline in interest rate peaks over time.

To continue reading: Living Dangerously

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US Budget Deficit Hits $530 Billion In 8 Months, As Spending On Interest Explodes, by Tyler Durden

Here’s the deteriorating US budget situation in pictures. From Tyler Durden at zerohedge.com:

The US is starting to admit that it has a spending problem.

According to the latest Monthly Treasury Statement, in May, the US collected $217BN in receipts – consisting of $93BN in individual income tax, $103BN in social security and payroll tax, $3BN in corporate tax and $18BN in other taxes and duties- a drop of 9.7% from the $240.4BN collected last March and a clear reversal from the recent increasing trend…

… even as Federal spending surged, rising 10.7% from $328.8BN last March to $363.9BN last month.

… where the money was spent on social security ($83BN), defense ($56BN), Medicare ($53BN), Interest on Debt ($32BN), and Other ($141BN).

The surge in spending led to a May budget deficit of $146.8 billion, above the consensus estimate of $144BN, a swing from a surplus of $214.3 billion in April and far larger than the deficit of $88.4 billion recorded in May of 2017. This was the biggest March budget deficit since the financial crisis.

To continue reading: US Budget Deficit Hits $530 Billion In 8 Months, As Spending On Interest Explodes

 

 

Debt Clock Ticking, by John Mauldin

The clock is ticking and the hour is very late. From John Mauldin at mauldineconomics.com:

Rather go to bed without dinner than to rise in debt.

—Benjamin Franklin

What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?

—Adam Smith

There are no shortcuts when it comes to getting out of debt.

—Dave Ramsey

Modern slaves are not in chains, they are in debt.

—Anonymous

Debt isn’t always a form of slavery, but those old sayings didn’t come from nowhere. You can find hundreds of quotes on the Internet discussing the problems of debt. Debt traps borrowers, lenders, and innocent bystanders, too. If debt were a drug, we would demand it be outlawed.

The advantage of debt is it lets you bring the future into the present, buying things you couldn’t afford if you had to pay full price now. This can be good or bad, depending on what you buy. Going into debt for education that will raise your income, or for factory equipment that will increase your output, can be positive. Debt for a tropical vacation, probably not.

And that’s our core economic problem. The entire world went into debt for the equivalent of tropical vacations and, having now enjoyed them, realizes it must pay the bill. The resources to do so do not yet exist. So, in the time-honored tradition of lenders everywhere, we extend and pretend. But with our ability to pretend almost gone, we’re heading to the Great Reset.

I’ve been analogizing our fate to a train wreck you know is coming but are powerless to stop. You look away because watching the disaster hurts, but it happens anyway. That’s where we are, like it or not.

And we don’t even really like to talk about it in polite circles. In a private email conversation this week, which must remain anonymous, this pithy line jumped out at me:

The total of Federal (remember they do not use GAAP) debt, state debt, and city debt [unfunded liabilities included] exceeds $200 trillion dollars. There is no set of math that works to pay this off. Let me be sure it’s heard by repeating it: There is no set of math that works to pay this off. Therefore, there has to be some form of remediation. This conversation is uncomfortable, so it is avoided.

Today’s letter is chapter 5 in my Train Crash series. If you’re just joining us, here are links to help you catch up.

Last week, we discussed the Italian political crisis and potential eurozone breakdown. That is a dangerous possibility, but far from the only one. As we’ll see today, the world has so much debt that the cracks could happen anywhere.

To continue reading: Debt Clock Ticking

The Coming Collision Of Debt and Rates, by Lance Roberts

The heavily indebted world can hardly afford higher interest rates. From Lance Roberts at realinvestmentadvice.com, via zerohedge.com:

On Tuesday, I discussed the issue of what has historically happened to the financial markets when both the dollar and rates are rising simultaneously. To wit:

“With the 10-year treasury rate now extremely overbought on a monthly basis, combined with a stronger dollar, the impact historically has not been kind to stock market investors. While it doesn’t mean the market will “crash” today, or even next week, historically rising interest rates combined with a rising dollar has previously led to unexpected and unintended consequences previously.”

I wanted to reiterate this point after reading a recent comment from Jamie Dimon, CEO of JP Morgan, whom, as I have previously written about, makes rather “disconnected” statements from time to time.

“We’re probably in the sixth inning (of this economic cycle), and it’s very possible you’re going to see stronger growth in the U.S. I’ve heard people say, well, it’s looking like 2007. Completely untrue. There’s much less leverage in the system. The banks are much better capitalized.”

First, while he talks about banks being much better capitalized, the interesting question is:

“If banks are so well capitalized, why hasn’t FASB Rule 157 been reinstated?”

As I noted previously, FASB Rule 157 was repealed during the financial crisis to allow banks to mark bad assets to “face value” making balance sheets stronger than they appear. This served the purpose of reducing panic in the system, supported “Too Big To Fail” banks, and kept many banks in operation. But if banks are once again so well capitalized, leverage reduced and the economy firing on all cylinders – why is that repeal still in place today? And, if the financial system and economic environment are so strong, then why are Central Banks globally still utilizing “emergency measures” to support their economies?

Likely it is because economic growth remains tepid and banks are once again heavily leveraged as noted by Zero Hedge:

“It is by now well known that consolidated leverage in the system is at an all-time high, with both the IMF and the IIF calculating in April that total global debt has hit a new all-time high of $237 trillion, up $70 trillion in the past decade, and equivalent to a record 382% of developed and 210% of emerging market GDP.”

To continue reading: The Coming Collision Of Debt & Rates

NIRP’s Revenge: Italian Bonds Plunge, Worst Day in Decades, by Wolf Richter

Some market reactions to the Italian economic and political crisis, from Wolf Richter at wolfstreet.com:

Markets wail and gnash their teeth as “normalization” of Italian yields sets in.

On Tuesday, Italian bonds had their worst day in Eurozone existence, even worse than any day during the worst periods of the 2011 debt crisis. And this comes after they’d already gotten crushed on Monday, and after they’d gotten crushed last week. And this happened even as the ECB is carrying on its QE program, including the purchase of Italian government bonds; and even as it pursues its negative-interest-rate policy (NIRP). As bond prices plunge, yields spike by definition, and the spike in the two-year yield was spectacular, going from 0.3% on Monday morning to 2.73% on Tuesday end of day:

But note that until May 26, the two-year yield was still negative as part of the ECB’s interest rate repression. On that fateful day, the two-year yield finally crossed the red line into positive territory.

To this day, it remains inexplicable why the ECB decided that Italian yields with maturities of two years or less should be negative – that investors, or rather pension beneficiaries, etc., who own these misbegotten bonds, would need to pay the Italian government, one of the most indebted in the world, for the privilege of lending it money. But that scheme came totally unhinged just now.

The 10-year Italian government bond yield preformed a similar if not quite as spectacular a feat. Over Monday and Tuesday, it went from 2.37% to 3.18%:

But here’s the thing: Italian bonds – no matter what maturity – should never ever have traded with a negative yield. Their yields should always have been higher than US yields, given that the Italian government is in even worse financial shape than the US government. Italy’s debt-to-GDP ratio is 131%, and more importantly, it doesn’t even control its own currency and cannot on its own slough off a debt crisis by converting it into a classic currency crisis, which is how Argentina is dealing with its government spending. The central bank of Argentina recently jacked up its 30-day policy rate to 40% to keep the peso from collapsing further.

To continue reading: NIRP’s Revenge: Italian Bonds Plunge, Worst Day in Decades

12 Indications That The Next Major Global Economic Crisis Could Be Just Around The Corner, by Michael Snyder

You don’t have to look too hard to see some ominous portents for the global economy. From Michael Snyder at theeconomiccollapseblog.com:

There have not been so many trouble signs for the global economy in a very long time.  Analysts are sounding the alarm about junk bond defaults, the smart money is getting out of stocks at an astounding rate, mortgage rates are absolutely skyrocketing, and Europe is already facing a full blown financial meltdown.  Of course expectations that another global economic crisis will happen among the general population are probably at an all-time low right now, but the reality of the matter is that we are probably closer to a new one erupting than at any point since the last one in 2008.  Since the last financial crisis our long-term debt problems have just continued to grow, and there are many that believe that the next crisis will actually be far worse than what we experienced ten years ago.

So how bad are things at this moment?

The following are 12 indications that the next major global economic crisis could be just around the corner…

#1 The “smart money” is getting out of stocks at a rate that we haven’t seen since just before the financial crisis of 2008.

#2 Moody’s is warning that a “particularly large wave” of junk bond defaults is coming.  And as I have written about so many times before, junk bonds are often an early warning indicator for a major financial crisis.

#3 According to the FDIC, a closely watched category known as “assets of problem banks” more than tripled during the first quarter of 2018.  What that means is that some really big banks are now officially in “problem” territory.

#4 U.S. Treasury bonds are having the worst start to a year since the Great Depression.

#5 Mortgage interest rates just hit a 7 year high, and they have been rising at the fastest pace in nearly 50 years.  This is going to be absolutely crippling for the real estate and housing industries.

#6 Retail industry debt defaults have hit a record high in 2018.

To continue reading: 12 Indications That The Next Major Global Economic Crisis Could Be Just Around The Corner

Tales from “The Master of Disaster”, by MN Gordon

Rising interest rates will deflate asset prices. From MN Gordon at economicprism.com:

Daylight extends a little further into the evening with each passing day.  Moods ease.  Contentment rises.  These are some of the many delights the northern hemisphere has to offer this time of year.

As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening.  The yield on the 10-Year Treasury note has exceeded 3.12 percent.

If yields continue to rise, this one thing will change everything.  To properly understand the significance of rising interest rates some context is in order.  Where to begin?

In 1981, professional skateboarder Duane Peters was busy inventing tricks like the invert revert, the acid drop, and the fakie thruster, in empty Southern California swimming pools.  As part of his creative pursuits, he refined and perfected the art of self-destruction with supreme enthusiasm.  His many broken bones, concussions, and knocked out teeth earned him the moniker, “The Master of Disaster”.

But as The Master of Disaster was risking life and limb while pioneering the loop of death, the seeds of a mega-disaster were being planted.  In particular, the rising part of the interest rate cycle peaked out in 1981.  Then, over the next 35 years, interest rates fell and these seeds of mega-disaster were multiplied and scattered across the land.

Credit and Asset Prices

The relationship between interest rates and asset prices is generally straightforward.  Tight credit generally results in lower asset prices.  Loose credit generally results in higher asset prices.

When credit is cheap, and plentiful, individuals and businesses increase their borrowing to buy things they otherwise couldn’t afford.  For example, individuals, with massive jumbo loans, bid up the price of houses.  Businesses, flush with a seemingly endless supply of cheap credit, borrow money and use it to buy back shares of their stock…inflating its value and the value of executive stock options.

To continue reading: Tales from “The Master of Disaster”