Bond Market Commentaries

Reports Jun 27 2013
  • From 2007 the crises have grown - Central Banks can’t fix it alone!
    Whether it is Bill Gross of Pimco, Marc Faber, ourselves or so very many competent analysts in the financial world, to a man, are warning of the destructive power of rising interest rates. Now in addition to all of us, we have the central banker of central bankers, the Bank of International Settlements, giving a serious warning to developed world governments that it is perhaps too late to rely on growth to rescue the global economy from deflation.

    To their credit, central banks in the developed world have, in their supportive way, given muted recommendations of a similar nature, that governments and the entire political system should be instituting programs that stimulate economic activity from the ground up. But over the last six years after discussion after discussion, they have failed to give fundamental stimulative support to central banks to get developed world economies going. The democratic process itself, whether in the U.S. or in the Eurozone has conspired through partisan or national agendas to defeat a united move to stimulate growth even without intending to!

    Governments have made considerable efforts to reinforce the banking system, on which they depend for the working of the system, but have largely ignored the needs and aspirations of their voting base. We now look at not only ‘hung’ governments, but a disjoint from the people they represent. Consequently, the most pressing problems facing their electorate, the economic ones, have been badly mishandled, neglected or just plain ignored.

    After the ‘credit crunch’ of 2007/2008, involving ‘just’ the banking system, which nearly brought it down, U.S. efforts to ‘fix’ the problem  simply let it continue with some capital buffers, but the underlying problem has not really been addressed [the levees have been raised but another ‘storm surge’ could still knock them down]. After that we have seen the Sovereign debt crisis of the Eurozone nearly spread a destructive solvency crisis among the weaker members of the E.U. Not only have the problems there not been fixed [yes, the levees have been raised there too], but the structural problems have been starkly highlighted through awful unemployment levels, [56% among the youth 26% overall in the weaker member nations] but not fixed.

    Out of these structural problems not only do we find social unrest rising, but the people generally are expressing their disappointment in the democratic system as never before, feeling as they do the victims of government and banking failures.

    And now we are warned of a coming storm surge that so many now forecast, that of rising interest rates. Despite the fact, known from the beginning of the ‘credit crunch’, that central banking ‘cures’ are not enough by themselves, the developed world has relied on them to solve the crises. No doubt they will also be the scapegoats when the storm surges overwhelm the levees.

    The Bank of International Settlements Warning
    The Bank of International Settlements has warned that Banks face another global financial crisis worse than 2007-8 as a $10 trillion central bank bond mountain leaves them perilously exposed to higher interest rates.

    The Federal Reserve recently triggered a global tightening of interest rates with hints it may start to wind down its money printing as soon as this September.

    The problem is that higher interest rates mean lower bond prices, and the banks are full of this supposedly safe debt. HSBC perhaps the most conservative of the world’s large banks has 42% of its balance sheet in U.S. bonds.

    When interest rates go up the banks make losses on their huge bond portfolios as yields rise and prices fall. Global central banks have accumulated $10 trillion in bonds that will also face massive losses. The B.I.S. says, ‘Someone must ultimately hold the interest rate risk. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.’

    The B.I.S. has issued an urgent appeal for fiscal and monetary prudence well after the horse has bolted. They continue, “Public debt in most advanced economies has reached unprecedented levels in peacetime,’ says the report. ‘Even worse, official debt statistics understate the true scale of fiscal problems. The belief that governments do not face a solvency constraint is a dangerous illusion. Bond investors can and do punish governments hard and fast. Governments must redouble their efforts to ensure that their fiscal trajectories are sustainable. Growth will simply not be high enough on its own. Postponing the pain carries the risk of forcing consolidation under stress which is the current situation in a number of countries in southern Europe.’

    The BIS sees the global economy heading for a 1994-style bond market crash.