The bullish case is that interest rates are going up because the economy is recovering…well, no it is not. In fact, if you look at the numbers the economy is stalling from its QE aided lower plateau and about to plumb new lows. Just look under the hood of some of the reported numbers, last week for example the non-farm payrolls supposedly rose 175,000 jobs. If you look into it, some 75% were lower paying and non-skilled jobs…plus 205,000 jobs were “magically” created by the BLS. Without this monthly “fudge factor” the real number would have been a negative 30,000 jobs…which is what the economy actually feels and smells like.
But talking about bogus reporting is not what I’d like to write about, the important (and scary) thing is that rates ARE rising. Rising interest rates (even though they never should have gotten to these low levels in the first place) will cause all sorts of problems. Before I go any further I’d like to point out that with the exception of Japan (during the ‘90s and 2000’s), global interest rates are lower than they have been in some 400 years since bond markets began to exist. We live in a world where interest rates are lower than they ever have been AND in a world that is more leveraged and has less unencumbered collateral than at any point in recorded history.
So what “problems” could there be? Higher interest rates will obviously put a dent in consumer purchases since much of this is done on credit. Housing across the globe will deflate as incomes will pay for “less house” at higher interest rates. This is also true of farm, commercial, industrial and “skyscraper” real estate. Bond prices (you know, what everyone has scampered unknowingly into for safety) will get crushed as will the owners of bonds such as banks, brokers and insurance companies. Derivatives of all sorts whether direct bets on interest rates or contango/carry trades will also get blown up. (The problem here is “size.”) And it won’t matter whether you are a winner or a loser because winners will become losers when they do not get “paid” by a bankrupt and insolvent loser.
Lastly and unfortunately (for the citizens), another set of losers with increasing interest rates are Central Banks and sovereign treasuries themselves. Central Banks (the Fed lost $115 billion just last month alone) who have monetized debt will lose on their portfolios stuffed with bonds. They will lose and lose and then print and print more to stay solvent which will continue to debase their currency while Mother Nature presses for even higher interest rates. Then of course, you have the sovereign governments themselves. The U.S., for example, will be forced to payout every single dollar of tax revenue to pay interest alone once interest rates hit the “sky high” level of just 5%! Higher interest rates at this point are no longer a policy option to contain inflation because the “remedy” is also the poison that will kill the Golden Goose.
I titled this piece “Interest rates are going up because…” The “because” part is because the Central Banks have been forced into the role of “buyer of last resort.” They are buying up large proportions of new issuance but “leakage” is happening as existing bond owners see the writing on the wall and have turned into sellers. It is this additional “supply” that is forcing interest rates higher, NOT a stronger economy. Are there some sellers of bonds because they don’t want to “miss the boat” (the Titanic) of rising stock markets? I am sure that this is also so but the stock markets have risen in the first place as a bet on weaker currencies and thus higher inflation.
Lower interest rates were supposed to be the “cure.” It had always, ALWAYS worked in the past, but not this time. Not this time because the amount of debt and the lack of unencumbered collateral was far too large and not nearly enough to “reflate” the system. Currently there are many different “signs” that the end of the road is finally arriving, higher interest rates being just one of many. I have written another piece shortly after this one to wrap the many “signs” together with one piece of news that speaks volumes. Look for it to post later today.