As I noted in my 9/30 Fed Blog post, FRB-Chicago President Charles Evans told CNBC on Monday that he believes it would be "quite some time" before it's appropriate to start tightening. Evans sees June as a possibility for the first rate increase, but said on CNBC’s Squawk Box that if it were his decision, he'd wait even longer. “If you look at the risks, we ought to balance those and be concerned that sometimes coming out of zero [rates] ... is really a difficult proposition for the economies. And so I'd like to be patient.”
I predicted that there might be more tightening tantrums ahead if investors share Evans’ concerns that the economy might go wobbly on the first rate hike. Most economists believe that once the Fed starts raising rates, that will be a sure sign that the economy has finally achieved the long hoped-for “escape velocity,” which should be bullish for stocks.
Why might a small initial increase in the federal funds rate turn into a serious problem for the economy and the stock market? For starters, it could send the dollar to the moon. That would depress the dollar value of corporate profits earned abroad. It would also depress exports and boost imports.
A more disturbing scenario would be a collapse of the corporate bond market. Investors have been piling into the market as they’ve been reaching for yield. Corporations have responded by issuing bonds at a record pace. Data compiled by the Fed show that nonfinancial corporations (NFCs) raised a record $741 billion in the bond market over the past 12 months through July. A significant portion of those funds were used to refinance outstanding debt at lower yields. The Fed’s Flow of Funds data show that net issuance by NFCs totaled $287 billion over the past four quarters through Q2.
On Tuesday, the WSJposted an article titled, “Corporate Bond Sales Coming at Blockbuster Pace.” Here’s the main finding:
I predicted that there might be more tightening tantrums ahead if investors share Evans’ concerns that the economy might go wobbly on the first rate hike. Most economists believe that once the Fed starts raising rates, that will be a sure sign that the economy has finally achieved the long hoped-for “escape velocity,” which should be bullish for stocks.
Why might a small initial increase in the federal funds rate turn into a serious problem for the economy and the stock market? For starters, it could send the dollar to the moon. That would depress the dollar value of corporate profits earned abroad. It would also depress exports and boost imports.
A more disturbing scenario would be a collapse of the corporate bond market. Investors have been piling into the market as they’ve been reaching for yield. Corporations have responded by issuing bonds at a record pace. Data compiled by the Fed show that nonfinancial corporations (NFCs) raised a record $741 billion in the bond market over the past 12 months through July. A significant portion of those funds were used to refinance outstanding debt at lower yields. The Fed’s Flow of Funds data show that net issuance by NFCs totaled $287 billion over the past four quarters through Q2.
On Tuesday, the WSJposted an article titled, “Corporate Bond Sales Coming at Blockbuster Pace.” Here’s the main finding:
Bond sales from highly rated companies in the U.S. clocked a record pace through the third quarter, as companies took advantage of low rates and investors sought out securities that pay more interest than low-yielding government bonds.
Highly rated firms sold about $913 billion of bonds in the U.S. in the first nine months of 2014, up from $869 billion last year, according to Dealogic's figures, which go back to 1995. That puts the investment-grade U.S. market on pace to beat last year's record issuance of about $1.1 trillion, according to Dealogic.
Highly rated firms sold about $913 billion of bonds in the U.S. in the first nine months of 2014, up from $869 billion last year, according to Dealogic's figures, which go back to 1995. That puts the investment-grade U.S. market on pace to beat last year's record issuance of about $1.1 trillion, according to Dealogic.
On Monday, the WSJ posted a similar article about the European bond market titled, “Europe’s Corporate Borrowing Set to Hit Pre-Crisis Peak.” Emerging market borrowers have also been raising plenty of money in the global bond markets.
Lots of those bonds have been purchased by retail and institutional investors, some of whom might try to sell them when the Fed starts actually raising interest rates. The problem is that the corporate bond market tends to be illiquid on a good day. This could be a nightmare scenario for bond funds if they are faced with lots of redemption orders with few buyers for their bond holdings. During July, there was a record $3.6 trillion in bond funds and ETFs.
Blackrock, the world’s largest money manager, is concerned. That’s according to a 9/22 Bloomberg story titled, “BlackRock Urges Changes in ‘Broken’ Corporate Bond Market.” Here’s the main point:
Lots of those bonds have been purchased by retail and institutional investors, some of whom might try to sell them when the Fed starts actually raising interest rates. The problem is that the corporate bond market tends to be illiquid on a good day. This could be a nightmare scenario for bond funds if they are faced with lots of redemption orders with few buyers for their bond holdings. During July, there was a record $3.6 trillion in bond funds and ETFs.
Blackrock, the world’s largest money manager, is concerned. That’s according to a 9/22 Bloomberg story titled, “BlackRock Urges Changes in ‘Broken’ Corporate Bond Market.” Here’s the main point:
Banks have retained their stranglehold on corporate debt trading despite years of effort by BlackRock and other large investors to eliminate their oligopoly. The top 10 dealers control more than 90 percent of trading, according to a Sept. 15 report from research firm Greenwich Associates. To BlackRock, the dangers of price gaps and scant liquidity have been masked in a benign, low interest-rate environment, and need to be addressed before market stress returns.
If a minor initial Fed rate hike does destabilize global bond markets, then there probably won’t be a second rate hike. That would seriously damage the credibility of the Fed, where the official party line has been that exiting ultra-easy monetary policy won’t be a problem.
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