Over the last few weeks you have seen more than just an increase in stock and bond market volatility. Now there is mounting evidence that the key global interest rates and credit markets are starting to show troubling indications of stress. This is often a warning sign of a pending yet unknown market or economic problem.
One of the most concerning telltale signs has been the recent jump in the U.S. dollar version of Libor. Libor refers to the London Interbank Offered rate. Literally trillions of dollars in contracts (such as personal and corporate loans) depend on this rate in the U.S. and around the world.
The Libor rate is all the more important because it reacts to financial stress and shortages in liquidity in the global money markets. This has been the case going back to the Global Financial Crisis and well before it.
The 12 month Libor has held steady around almost 2.7 percent in recent weeks. Throughout the year it has continued to rise. To date no analysts have been able to sufficiently account for the ongoing increase in the crucial rate. This graph shows the rise of the US dollar denominated Libor:
By itself the unexplained rising rate indicates enough trouble. It is more concerning when coupled with two other interest rate factors. The U.S. yield curve has been flattening. Credit spreads are also widening simultaneously.
Taken together the three indicators are flashing an almost overlooked warning. A hidden but significant distress lurks somewhere in the world’s financial markets. Market participants may not be aware of what the source is right now.
Clearly the credit and interest rate markets are nervous for some reason. For example, over the last two weeks money fleeing the stock markets has taken refuge in the ten year Treasuries. Prices are inverse to yield. This has caused the Treasury yields to drop to 2.78 percent.
When you measure the ten year yields against the two year yields, you get a yield curve that recently flattened down to only 51 basis points. This half percentage mark was only minutely higher than the lowest point for the year.
Skeptics might also consider the December Fed fund futures levels. These have been rallying lately. The increasing price hints that bond market traders do not take the Federal Reserve seriously. It has promised to aggressively increase interest rates for 2018. It would take a significant change in economic or market indicators to dissuade the Fed from making good on their interest rate boosting at this point.
With the effective Fed Funds rate notching 1.7 percent following the Federal Reserve’s recent hike the key interest rate is now higher than today’s level of inflation. Bond Market Strategist Kathy Jones of Charles Schwab has pointed out that this means the Federal Reserve policy has become restrictive (as opposed to previously accommodative). This has not happened since the Global Financial Crisis of 2008.
Is Your Retirement Portfolio Protected from the Global Credit Market Strain Warnings?
More restrictive Fed policies may be enough to explain the wild recent volatility and price swings in stocks and bonds. They do not account for the strains that the global credit markets are revealing. The good news is that you do not have stay up late trying to figure out what the warning means. Gold has a proven track record of protecting from economic uncertainty.
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