Bond Investors

We Are Being Set Up For Higher Interest Rates, A Major Recession And A Giant Stock Market Crash

November 20, 2016November 20, 2016 by Michael

Since Donald Trump’s victory on election night we have seen the worst bond crash in 15 years. Global bond investors have seen trillions of dollars of wealth wiped out since November 8th, and analysts are warning of another tough week ahead. The general consensus in the investing community is that a Trump administration will mean much higher inflation, and as a result investors are already starting to demand higher interest rates. Unfortunately for all of us, history has shown that higher interest rates always cause an economic slowdown. And this makes perfect sense, because economic activity naturally slows down when it becomes more expensive to borrow money. The Obama administration had already set up the next president for a major recession anyway, but now this bond crash threatens to bring it on sooner rather than later.

For those that are not familiar with the bond market, when yields go up bond prices go down. And when bond prices go down, that is bad news for economic growth.

So we generally don’t want yields to go up.

Unfortunately, yields have been absolutely soaring over the past couple of weeks, and the yield on 10 year Treasury notes has now jumped “one full percentage point since July”…

The 10-year Treasury yield jumped to 2.36% in late trading on Friday, the highest since December 2015, up 66 basis point since the election, and up one full percentage point since July!

The 10-year yield is at a critical juncture. In terms of reality, the first thing that might happen is a rate increase by the Fed in December, after a year of flip-flopping. A slew of post-election pronouncements by Fed heads – including Yellen’s “relatively soon” – have pushed the odds of a rate hike to 98%.

As I noted the other day, so many things in our financial system are tied to yields on U.S. Treasury notes. Just look at what is happening to mortgages. As Wolf Richter has noted, the average rate on 30 year mortgages is shooting into the stratosphere…

The carnage in bonds has consequences. The average interest rate of the a conforming 30-year fixed mortgage as of Friday was quoted at 4.125% for top credit scores. That’s up about 0.5 percentage point from just before the election, according to Mortgage News Daily. It put the month “on a short list of 4 worst months in more than a decade.”

If mortgage rates continue to shoot higher, there will be another housing crash.

Rates on auto loans, credit cards and student loans will also be affected. Throughout our economic system it will become much more costly to borrow money, and that will inevitably slow the overall economy down.

Why bond investors are so on edge these days is because of statements such as this one from Steve Bannon…

In a nascent administration that seems, at best, random in its beliefs, Bannon can seem to be not just a focused voice, but almost a messianic one:

“Like [Andrew] Jackson’s populism, we’re going to build an entirely new political movement,” he says. “It’s everything related to jobs. The conservatives are going to go crazy. I’m the guy pushing a trillion-dollar infrastructure plan. With negative interest rates throughout the world, it’s the greatest opportunity to rebuild everything. Ship yards, iron works, get them all jacked up. We’re just going to throw it up against the wall and see if it sticks. It will be as exciting as the 1930s, greater than the Reagan revolution — conservatives, plus populists, in an economic nationalist movement.”

Steve Bannon is going to be one of the most influential voices in the new Trump administration, and he is absolutely determined to get this “trillion dollar infrastructure plan” through Congress.

And that is going to mean a lot more borrowing and a lot more spending for a government that is already on pace to add 2.4 trillion dollars to the national debt this fiscal year.

Sadly, all of this comes at a time when the U.S. economy is already starting to show significant signs of slowing down. It is being projected that we will see a sixth straight decline in year-over-year earnings for the S&P 500, and industrial production has now contracted for 14 months in a row.

The truth is that the economy has been barely treading water for quite some time now, and it isn’t going to take much to push us over the edge. The following comes from Lance Roberts…

With an economy running at below 2%, consumers already heavily indebted, wage growth weak for the bulk of American’s, there is not a lot of wiggle room for policy mistakes.

Combine weak economics with higher interest rates, which negatively impacts consumption, and a stronger dollar, which weighs on exports, and you have a real potential of a recession occurring sooner rather than later.

Yes, the stock market soared immediately following Trump’s election, but it wasn’t because economic conditions actually improved.

If you look at history, a stock market crash almost always follows a major bond crash. So if bond prices keep declining rapidly that is going to be a very ominous sign for stock traders.

And history has also shown us that no bull market can survive a major recession. If the economy suffers a major downturn early in the Trump administration, it is inevitable that stock prices will follow.

The waning days of the Obama administration have set us up perfectly for higher interest rates, a major recession and a giant stock market crash.

Of course any problems that occur after January 20th, 2017 will be blamed on Trump, but the truth is that Obama will be far more responsible for what happens than Trump will be.

Right now so many people have been lulled into a sense of complacency because Donald Trump won the election.

That is an enormous mistake.

A shaking has already begun in the financial world, and this shaking could easily become an avalanche.

Now is not a time to party. Rather, it is time to batten down the hatches and to prepare for very rough seas ahead.

All of the things that so many experts warned were coming may have been delayed slightly, but without a doubt they are still on the way.

So get prepared while you still can, because time is running out.

The Most Important Number In The Entire U.S. Economy

July 31, 2013 by Michael

There is one vitally important number that everyone needs to be watching right now, and it doesn’t have anything to do with unemployment, inflation or housing. If this number gets too high, it will collapse the entire U.S. financial system. The number that I am talking about is the yield on 10 year U.S. Treasuries. When that number goes up, long-term interest rates all across the financial system start increasing. When long-term interest rates rise, it becomes more expensive for the federal government to borrow money, it becomes more expensive for state and local governments to borrow money, existing bonds lose value and bond investors lose a lot of money, mortgage rates go up and monthly payments on new mortgages rise, and interest rates throughout the entire economy go up and this causes economic activity to slow down. On top of everything else, there are more than 440 trillion dollars worth of interest rate derivatives sitting out there, and rapidly rising interest rates could cause that gigantic time bomb to go off and implode our entire financial system. We are living in the midst of the greatest debt bubble in the history of the world, and the only way that the game can continue is for interest rates to stay super low. Unfortunately, the yield on 10 year U.S. Treasuries has started to rise, and many experts are projecting that it is going to continue to rise.

On August 2nd of last year, the yield on 10 year U.S. Treasuries was just 1.48%, and our entire debt-based economy was basking in the glow of ultra-low interest rates. But now things are rapidly changing. On Wednesday, the yield on 10 year U.S. Treasuries hit 2.70% before falling back to 2.58% on “good news” from the Federal Reserve.

Historically speaking, rates are still super low, but what is alarming is that it looks like we hit a “bottom” last year and that interest rates are only going to go up from here. In fact, according to CNBC many experts believe that we will soon be pushing up toward the 3 percent mark…

Round numbers like 1,700 on the S&P 500 are well and good, but savvy traders have their minds on another integer: 2.75 percent

That was the high for the 10-year yield this year, and traders say yields are bound to go back to that level. The one overhanging question is how stocks will react when they see that number.

“If we start to push up to new highs on the 10-year yield so that’s the 2.75 level—I think you’d probably see a bit of anxiety creep back into the marketplace,” Bank of America Merrill Lynch’s head of global technical strategy, MacNeil Curry, told “Futures Now” on Tuesday.

And Curry sees yields getting back to that level in the short term, and then some. “In the next couple of weeks to two months or so I think we’ve got a push coming up to the 2.85, 2.95 zone,” he said.

This rise in interest rates has been expected for a very long time – it is just that nobody knew exactly when it would happen. Now that it has begun, nobody is quite sure how high interest rates will eventually go. For some very interesting technical analysis, I encourage everyone to check out an article by Peter Brandt that you can find right here.

And all of this is very bad news for stocks. The chart below was created by Chartist Friend from Pittsburgh, and it shows that stock prices have generally risen as the yield on 10 year U.S. Treasuries has steadily declined over the past 30 years…

When interest rates go down, that spurs economic activity, and that is good for stock prices.

So when interest rates start going up rapidly, that is not a good thing for the stock market at all.

The Federal Reserve has tried to keep long-term interest rates down by wildly printing money and buying bonds, and even the suggestion that the Fed may eventually “taper” quantitative easing caused the yield on 10 year U.S. Treasuries to absolutely soar a few weeks ago.

So the Fed has backed off on the “taper” talk for now, but what happens if the yield on 10 year U.S. Treasuries continues to rise even with the wild money printing that the Fed has been doing?

At that point, the Fed would begin to totally lose control over the situation. And if that happens, Bill Fleckenstein told King World News the other day that he believes that we could see the stock market suddenly plunge by 25 percent…

Let’s say Ben (Bernanke) comes out tomorrow and says, ‘We are not going to taper.’ But let’s just say the bond market trades down anyway, and the next thing you know we go through the recent highs and a month from now the 10-Year is at 3%. And people start to realize they are not even tapering and the bond market is backed up….

They will say, ‘Why is this happening?’ Then they may realize the bond market is discounting the inflation we already have.

At some point the bond markets are going to say, ‘We are not comfortable with these policies.’ Obviously you can’t print money forever or no emerging country would ever have gone broke. So the bond market starts to back up and the economy gets worse than it is now because rates are rising. So the Fed says, ‘We can’t have this,’ and they decide to print more (money) and the bond market backs up (even more).

All of the sudden it becomes clear that money printing not only isn’t the solution, but it’s the problem. Well, with rates going from where they are to 3%+ on the 10-Year, one of these days the S&P futures are going to get destroyed. And if the computers ever get loose on the downside the market could break 25% in three days.

And as I have written about previously, we have seen a huge spike in margin debt in recent months, and this could make it even easier for a stock market collapse to happen. A recent note from Deutsche Bank explained precisely why margin debt is so dangerous…

Margin debt can be described as a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. These loans are collateralized by stock holdings, so when the market goes south, investors are either required to inject more cash/assets or become forced to sell immediately to pay off their loans – sometimes leading to mass pullouts or crashes.

But of much greater concern than a stock market crash is the 441 trillion dollar interest rate derivatives bubble that could implode if interest rates continue to rise rapidly.

Deutsche Bank is the largest bank in Europe, and at this point they have 55.6 trillion euros of total exposure to derivatives.

But the GDP of the entire nation of Germany is only about 2.7 trillion euros for a whole year.

We are facing a similar situation in the United States. Our GDP for 2013 will be somewhere between 15 and 16 trillion dollars, but many of our big banks have exposure to derivatives that absolutely dwarfs our GDP. The following numbers come from one of my previous articles entitled “The Coming Derivatives Panic That Will Destroy Global Financial Markets“…

JPMorgan Chase

Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)

Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)

Citibank

Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)

Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)

Bank Of America

Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)

Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)

Goldman Sachs

Total Assets: $114,693,000,000 (a bit more than 114 billion dollars – yes, you read that correctly)

Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)

That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets.

And remember, the biggest chunk of those derivatives contracts is made up of interest rate derivatives.

Just imagine what would happen if a life insurance company wrote millions upon millions of life insurance contracts and then everyone suddenly died.

What would happen to that life insurance company?

It would go completely broke of course.

Well, that is what our major banks are facing today.

They have written trillions upon trillions of dollars worth of interest rate derivatives contracts, and they are betting that interest rates will not go up rapidly.

But what if they do?

And the truth is that interest rates have a whole lot of room to go up. The chart below shows how the yield on 10 year U.S. Treasuries has moved over the past couple of decades…

As you can see, the yield on 10 year U.S. Treasuries was hovering around the 6 percent mark back in the year 2000.

Back in 1990, the yield on 10 year U.S. Treasuries hovered between 8 and 9 percent.

If we return to “normal” levels, our financial system will implode. There is no way that our debt-addicted system would be able to handle it.

So watch the yield on 10 year U.S. Treasuries very carefully. It is the most important number in the entire U.S. economy.

If that number gets too high, the game is over.

A Nightmare Scenario

July 16, 2013 by Michael

Most people have no idea that the U.S. financial system is on the brink of utter disaster. If interest rates continue to rise rapidly, the U.S. economy is going to be facing an economic crisis far greater than the one that erupted back in 2008. At this point, the economic paradigm that the Federal Reserve has constructed only works if interest rates remain super low. If they rise, everything falls apart. Much higher interest rates would mean crippling interest payments on the national debt, much higher borrowing costs for state and local governments, trillions of dollars of losses for bond investors, another devastating real estate crash and the possibility of a multi-trillion dollar derivatives meltdown. Everything depends on interest rates staying low. Unfortunately for the Fed, it only has a certain amount of control over long-term interest rates, and that control appears to be slipping. The yield on 10 year U.S. Treasuries has soared in recent weeks. So have mortgage rates. Fortunately, rates have leveled off for the moment, but if they resume their upward march we could be dealing with a nightmare scenario very, very quickly.

In particular, the yield on 10 year U.S. Treasuries is a very important number to watch. So much else in our financial system depends on that number as CNN recently explained…

Indeed, since May, just before Bernanke announced a probable end to QE3, the yield on 10-year Treasuries has jumped around almost one percentage point, to 2.6%, wiping out more than two years of interest payments. The markets clearly fear that far higher long-term rates are lurking in the absence of exceptional policies to rein them in.

That’s a crucial issue, because those rates are highly influential in determining the future performance of stocks, bonds, and real estate. Investors grant equities higher multiples when long-term rates are lower; both longer-maturity Treasuries and corporate bonds jump when rates decline; and developers pocket more cash flow from their projects when they borrow cheaply, raising the values of office and apartment buildings. When rates reverse course, so do all of those prices the Fed has been endeavoring to swell as a tonic for the economy.

Even though the yield on 10 year U.S. Treasuries has risen substantially, it is still very low. It has a lot more room to go up. In fact, as the chart posted below demonstrates, the yield on 10 year U.S. Treasuries was above 6 percent back in the year 2000…

And the yield on 10 year U.S. Treasuries should rise substantially. It simply is not rational to lend the U.S. government money at less than 3 percent when the real rate of inflation is about 8 percent, the Federal Reserve is rapidly debasing the currency by wildly printing money and the federal government has been piling up debt as if there is no tomorrow…

Anyone that lends the U.S. government money at current rates is being very foolish. You will end up getting back money that has much less purchasing power than you originally invested.

Why would anyone do that?

But if interest rates rise, the U.S. government could be looking at some very hairy interest payments very rapidly. For example, if the average rate of interest on U.S. government debt just gets back to 6 percent (and it has been far higher than that in the past), the federal government will be shelling out a trillion dollars a year just in interest on the national debt.

State and local governments all over the nation could also very rapidly be facing a nightmare scenario.

Detroit is already on the verge of formally declaring the largest municipal bankruptcy in the history of the United States, and there are many other state and local governments from coast to coast that are rapidly heading toward financial disaster even though borrowing costs are super low right now.

If interest rates start rising dramatically, it would cause a huge wave of municipal financial disasters, and municipal bond investors would lose massive amounts of money…

“Muni bond investors are in for the shock of their lives,” said financial advisor Ric Edelman. “For the past 30 years there hasn’t been interest rate risk.”

That risk can be extreme. A one-point rise in the interest rate could cut 10 percent of the value of a municipal bond with a longer duration, he said.

Many retail buyers, though, are not ready for the change and “when it starts, it will be too late for them to react,” he said, adding that he was encouraging investors to look at their portfolio allocation and make changes to protect themselves from interest rate risks now.

In fact, bond investors of all types could be facing monstrous losses if interest rates go up dramatically.

It is being projected that if U.S. Treasury yields rise by an average of 3 percentage points, it will cause bond investors to lose a trillion dollars.

And already we have started to see a race for the exits in the bond market. A total of 80 billion dollars was pulled out of bond funds during the month of June alone. If you want a visual of the flow of money out of the bond market, just check out the chart in this article.

We are witnessing things happen in the financial markets that have not happened in a very, very long time.

And junk bonds will be hit particularly hard. About a decade ago, the average yield on junk bonds was about twice what it is right now. When the junk bond crash comes, there is going to be mass carnage on Wall Street.

But of much greater importance to most Americans is what is happening to mortgage rates. As mortgage rates rise, it becomes much more difficult to sell a house and much more expensive to buy a house.

According to CNBC, there is an increasing amount of concern that the rise in mortgage rates that we are witnessing could throw the real estate market into absolute turmoil…

The housing recovery is in for a major pause due to higher mortgage rates. It is not in the numbers now, and it won’t be for a few months, but it is coming, according to one noted analyst. The market has seen rising rates before, but never so far so fast; there is no precedent for a 45 percent spike in just six weeks. The spike is causing a sense of urgency now, a rush to buy before rates go higher, but that will be short term. Home sales and home prices will both come down if rates don’t return to their lows, and the expectation is that they will not.

We have seen the number of mortgage applications fall for four weeks in a row, and at this point mortgage applications have declined by 28 percent over the past month.

That is an absolutely stunning decline, but it just shows the power of interest rates.

Let’s try to put this into real world terms.

A year ago, the 30 year rate was sitting at 3.66 percent. The monthly payment on a 30 year, $300,000 mortgage at that rate would be $1374.07.

If the 30 year rate rises to 8 percent, the monthly payment on a 30 year, $300,000 mortgage at that rate would be $2201.29.

Does 8 percent sound crazy to you?

It shouldn’t. 8 percent was considered to be normal back in the year 2000…

This is what we are talking about when we talk about the “bubbles” that the Federal Reserve has created. The housing market is now completely and totally dependent on these artificially low mortgage rates. If rates go back to “normal”, the results would be absolutely devastating.

But of course the biggest problem with rapidly rising interest rates is the potential for a derivatives crisis.

There are several major U.S. banks that have tens of trillions of dollars of exposure to derivatives. The following is from one of my previous articles entitled “The Coming Derivatives Panic That Will Destroy Global Financial Markets“…

JPMorgan Chase

Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)

Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)

Citibank

Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)

Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)

Bank Of America

Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)

Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)

Goldman Sachs

Total Assets: $114,693,000,000 (a bit more than 114 billion dollars – yes, you read that correctly)

Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)

That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets.

The largest chunk of those derivatives contracts is made up of interest rate derivatives.

I have mentioned this so many times before, but it bears repeating that there are approximately 441 trillion dollars worth of interest rate derivatives sitting out there.

If rapidly rising interest rates suddenly cause trillions of dollars of those bets to start going bad, we could potentially see several of the “too big to fail” banks collapse at the same time.

So what would happen then?

Would the federal government and the Federal Reserve somehow come up with trillions of dollars (or potentially even tens of trillions of dollars) to bail them out?

The Federal Reserve has created a giant mess, and when this current low interest rate bubble ends our financial system is going to slam very violently into a very solid brick wall.

As Graham Summers recently pointed out, entrusting Federal Reserve Chairman Ben Bernanke with control of our financial system is like putting a madman behind the wheel of a speeding vehicle…

Imagine if you were in the car with a driver who was going 85 MPH down a road with a speed limit of 35 MPH (this isn’t a bad metaphor as there is absolutely no evidence that QE creates jobs or GDP growth so there is no reason for the Fed to be doing it in the first place).

The guy is obviously out of control. The dangers of driving this fast are myriad (crashing, running someone over, etc.) while the benefits (you might get where you want to go a little faster assuming you don’t crash) are minimal.

Now imagine that the driver turned to you and said, “I’m thinking about slowing down.” Seems like a great idea doesn’t it? But then a mere two minutes later he says “ we need to continue at 85 MPH for the foreseeable future.”

At this point any sane person would scream, “STOP.” The driver is clearly a madman and shouldn’t be let anywhere near the driver’s seat. Moreover, he’s totally lost all credibility and isn’t to be trusted.

That’s our Fed Chairman.

Sadly, most Americans do not understand any of this.

Most Americans have no idea about the immense economic pain that is going to hit us when interest rates go back to normal levels.

All of this could have been avoided, but instead the American people let the central planners over at the Federal Reserve run wild.

When the bubble finally bursts, the official unemployment rate is going to rocket well up into the double digits, millions of families will lose their homes and America will find itself in the middle of the worst economic crisis in modern U.S. history.

Please share this article with as many people as you can. We need to help people understand what is coming so that they will not be blindsided by it.

The Trigger Has Been Pulled And The Slaughter Of The Bonds Has Begun

June 25, 2013 by Michael

What does it look like when a 30 year bull market ends abruptly? What happens when bond yields start doing things that they haven’t done in 50 years? If your answer to those questions involves the word “slaughter”, you are probably on the right track. Right now, bonds are being absolutely slaughtered, and this is only just the beginning. Over the last several years, reckless bond buying by the Federal Reserve has forced yields down to absolutely ridiculous levels. For example, it simply is not rational to lend the U.S. government money at less than 3 percent when the real rate of inflation is somewhere up around 8 to 10 percent. But when he originally announced the quantitative easing program, Federal Reserve Chairman Ben Bernanke said that he intended to force interest rates to go down, and lots of bond investors made a lot of money riding the bubble that Bernanke created. But now that Bernanke has indicated that the bond buying will be coming to an end, investors are going into panic mode and the bond bubble is starting to burst. One hedge fund executive told CNBC that the “feeling you are getting out there is that people are selling first and asking questions later”. And the yield on 10 year U.S. Treasuries just keeps going up. Today it closed at 2.59 percent, and many believe that it is going to go much higher unless the Fed intervenes. If the Fed does not intervene and allows the bubble that it has created to burst, we are going to see unprecedented carnage.

Markets tend to fall faster than they rise. And now that Bernanke has triggered a sell-off in bonds, things are moving much faster than just about anyone anticipated…

Wall Street never thought it would be this bad.

Over the last two months, and particularly over the last two weeks, investors have been exiting their bond investments with unexpected ferocity, moves that continued through Monday.

A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.

Instead, since the Federal Reserve chairman, Ben S. Bernanke, recently suggested that the strength of the economic recovery might allow the Fed to slow down its bond-buying program, waves of selling have convulsed the markets.

In particular, junk bonds are getting absolutely hammered. Money is flowing out of high risk corporate debt at an astounding pace…

The SPDR Barclays High Yield Bond exchange-traded fund has declined 5 percent over the past month, though it rose in Tuesday trading. The fund has seen $2.7 billion in outflows year to date, according to IndexUniverse.

Another popular junk ETF, the iShares iBoxx $ High Yield Corporate Bond, has seen nearly $2 billion in outflows this year and is off 3.4 percent over the past five days alone.

Investors pulled $333 million from high-yield funds last week, according to Lipper.

While correlating to the general trend in fixed income, the slowdown in the junk bond business bodes especially troubling signs for investment banks, which have relied on the debt markets for fully one-third of their business this year, the highest percentage in 10 years.

The chart posted below comes from the Federal Reserve, and it “represents the effective yield of the BofA Merrill Lynch US High Yield Master II Index, which tracks the performance of US dollar denominated below investment grade rated corporate debt publically issued in the US domestic market.” In other words, it is a measure of the yield on junk bonds. As you can see, the yield on junk bonds sank to ridiculous lows in May, but since then it has been absolutely skyrocketing…

So why should the average American care about this?

Well, if the era of “cheap money” is over and businesses have to pay more to borrow, that is going to cause economic activity to slow down.

There won’t be as many jobs, part-time workers will get less hours, and raises will become more infrequent.

Those are just some of the reasons why you should care about this stuff.

Municipal bonds are being absolutely crushed right now too. You see, when yields on U.S. government debt rise, they also rise on state and local government debt.

In fact, things have been so bad that hundreds of millions of dollars of municipal bond sales have been postponed in recent days…

With yields on the U.S. municipal bond market rising, local issuers on Monday postponed another six bond sales, totaling $331 million, that were originally scheduled to price later this week.

Since mid-June, on the prospect that the Federal Reserve could change course on its easy monetary policy as the economy improves, the municipal bond market has seen a total of $2.6 billion in sales either canceled or delayed.

If borrowing costs for state and local governments rise, they won’t be able to spend as much money, they won’t be able to hire as many workers, they will need to find more revenue (tax increases), and more of them will go bankrupt.

And what we are witnessing right now is just the beginning. Things are going to get MUCH worse. The following is what Robert Wenzel recently had to say about the municipal bond market…

Thus, there is only one direction for rates: UP, with muni bonds leading the decline, given that the financial structures of many municipalities are teetering. There is absolutely no good reason to be in municipal bonds now. And muni ETFs will be a worse place to be, given this is relatively HOT money that will try to get out of the exit door all at once.

But, as I wrote about yesterday, the worst part of the slaughter is going to be when the 441 trillion dollar interest rate derivatives time bomb starts exploding. If bond yields continue to soar, eventually it will take down some very large financial institutions. The following is from a recent article by Bill Holter…

Please understand how many of these interest rate derivatives work. When the rates go against you, “margin” must be posted. By “margin” I mean collateral. Collateral must be shifted from the losing institution to the one on the winning side. When the loser “runs out” of collateral…that is when you get a situation similar to MF Global or Lehman Bros., they are forced to shut down and the vultures then come in and pick the bones clean…normally. Now it is no longer “normal,” now a Lehman Bros will take the whole tent down.

Most people have no idea how vulnerable our financial system is. It is a house of cards of risk, debt and leverage. Wall Street has become the largest casino in the history of the planet, and the wheels could come off literally at any time.

And it certainly does not help that a whole host of cyclical trends appear to be working against us. Posted below is an extended excerpt from a recent article by Taki Tsaklanos and GE Christenson…

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Charles Nenner Research (source)

Stocks should peak in mid-2013 and fall until about 2020. Similarly, bonds should peak in the summer of 2013 and fall thereafter for 20 years. He bases his conclusions entirely on cycle research. He expects the Dow to fall to around 5,000 by 2018 – 2020.

Kress Cycles by Clif Droke (source)

The major 120 year cycle plus all minor cycles trend down into late 2014. The stock market should decline hard into late 2014.

Elliott Wave Cycles by Robert Prechter (source)

He believes that the stock market has peaked and has entered a generational bear-market. He anticipates a crash low in the market around 2016 – 2017.

Market Energy Wave (source)

He sees a 36 year cycle in stock markets that is peaking in mid-2013 and down 2013 – 2016. “… the controlling energy wave is scheduled to flip back to negative on July 19 of this year.” Equity markets should drop 25 – 50%.

Armstrong Economics (source)

His economic confidence model projects a peak in confidence in August 2013, a bottom in September 2014, and another peak in October 2015. The decline into January 2020 should be severe. He expects a world-wide crash and contraction in economies from 2015 – 2020.

Cycles per Charles Hugh Smith (source)

He discusses four long-term cycles that bottom roughly in the 2010 – 2020 period. They are: Credit expansion/contraction cycle; Price inflation/wage cycle; Generational cycle; and Peak oil extraction cycle.

Harry Dent – Demographics (source)

Stock prices should drop, on average for the balance of this decade. Demographic cycles in the United States (and elsewhere) indicate a contraction in real terms for most of this decade.

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I was stunned when I originally read through that list.

Is it just a coincidence that so many researchers have come to such a similar conclusion?

The central banks of the world could attempt to “kick the can down the road” by buying up lots and lots of bonds, but it does not appear that is going to happen.

The Federal Reserve may not listen to the American people, but there is one institution that the Fed listens to very carefully – the Bank for International Settlements. It is the central bank of central banks, and today 58 global central banks belong to the BIS. Every two months, the central bankers of the world (including Bernanke) gather in Basel, Switzerland for a “Global Economy Meeting”. At those meetings, decisions are made which affect every man, woman and child on the planet.

And the BIS has just come out with its annual report. In that annual report, the BIS says that central banks “cannot do more without compounding the risks they have already created”, and that central banks should “encourage needed adjustments” in the financial markets. In other words, the BIS is saying that it is time to end the bond buying…

The Basel-based BIS – known as the central bank of central banks – said in its annual report that using current monetary policy employed in the euro zone, the U.K., Japan and the U.S. will not bring about much-needed labor and product market reforms and is a recipe for failure.

“Central banks cannot do more without compounding the risks they have already created,” it said in its latest annual report released on Sunday. “[They must] encourage needed adjustments rather than retard them with near-zero interest rates and purchases of ever-larger quantities of government securities.”

So expect central banks to start scaling back their intervention in the marketplace.

Yes, this is probably going to cause interest rates to rise dramatically and cause all sorts of chaos as the bubble that they created implodes.

It could even potentially cause a worse financial crisis than we saw back in 2008.

If that happens, the central banks of the world can swoop in and try to save us with their bond buying once again.

Isn’t our system wonderful?

The 441 TRILLION Dollar Interest Rate Derivatives Time Bomb

June 24, 2013June 24, 2013 by Michael

Do you want to know the primary reason why rapidly rising interest rates could take down the entire global financial system? Most people might think that it would be because the U.S. government would have to pay much more interest on the national debt. And yes, if the average rate of interest on U.S. government debt rose to just 6 percent (and it has actually been much higher in the past), the federal government would be paying out about a trillion dollars a year just in interest on the national debt. But that isn’t it. Nor does the primary reason have to do with the fact that rapidly rising interest rates would impose massive losses on bond investors. At this point, it is being projected that if U.S. bond yields rise by an average of 3 percentage points, it will cause investors to lose a trillion dollars. Yes, that is a 1 with 12 zeroes after it ($1,000,000,000,000). But that is not the number one danger posed by rapidly rising interest rates either. Rather, the number one reason why rapidly rising interest rates could cause the entire global financial system to crash is because there are more than 441 TRILLION dollars worth of interest rate derivatives sitting out there. This number comes directly from the Bank for International Settlements – the central bank of central banks. In other words, more than $441,000,000,000,000 has been bet on the movement of interest rates. Normally these bets do not cause a major problem because rates tend to move very slowly and the system stays balanced. But now rates are starting to skyrocket, and the sophisticated financial models used by derivatives traders do not account for this kind of movement.

So what does all of this mean?

It means that the global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar.

Today, the yield on 10 year U.S. Treasury bonds rocketed up to 2.66% before settling back to 2.55%. The chart posted below shows how dramatically the yield on 10 year U.S. Treasuries has moved in recent days…

Right now, the yield on 10 year U.S. Treasuries is about 30 percent above its 50 day moving average. That is the most that it has been above its 50 day moving average in 50 years.

Like I mentioned above, we are moving into uncharted territory and this data doesn’t really fit into the models used by derivatives traders.

The yield on 5 year U.S. Treasuries has been moving even more dramatically…

Last week, the yield on 5 year U.S. Treasuries rose by an astounding 37 percent. That was the largest increase in 50 years.

Once again, this is uncharted territory.

If rates continue to shoot up, there are going to be some financial institutions out there that are going to start losing absolutely massive amounts of money on interest rate derivative contracts.

So exactly what is an interest rate derivative?

The following is how Investopedia defines interest rate derivatives…

A financial instrument based on an underlying financial security whose value is affected by changes in interest rates. Interest-rate derivatives are hedges used by institutional investors such as banks to combat the changes in market interest rates. Individual investors are more likely to use interest-rate derivatives as a speculative tool – they hope to profit from their guesses about which direction market interest rates will move.

They can be very complicated, but I prefer to think of them in very simple terms. Just imagine walking into a casino and placing a bet that the yield on 10 year U.S. Treasuries will hit 2.75% in July. If it does reach that level, you win. If it doesn’t, you lose. That is a very simplistic example, but I think that it is a helpful one. At the heart of it, the 441 TRILLION dollar derivatives market is just a bunch of people making bets about which way interest rates will go.

And normally the betting stays very balanced and our financial system is not threatened. The people that run this betting use models that are far more sophisticated than anything that Las Vegas uses. But all models are based on human assumptions, and wild swings in interest rates could break their models and potentially start causing financial losses on a scale that our financial system has never seen before.

We are potentially talking about a financial collapse far worse than anything that we saw back in 2008.

Remember, the U.S. national debt is just now approaching 17 trillion dollars. So when you are talking about 441 trillion dollars you are talking about an amount of money that is almost unimaginable.

Meanwhile, China appears to be on the verge of another financial crisis as well. The following is from a recent article by Graham Summers…

China is on the verge of a “Lehman” moment as its shadow banking system implodes. China had pumped roughly $1.6 trillion in new credit (that’s 21% of GDP) into its economy in the last two quarters… and China GDP growth is in fact slowing.

This is what a credit bubble bursting looks like: the pumping becomes more and more frantic with less and less returns.

And Chinese stocks just experienced their largest decline since 2009. The second largest economy on earth is starting to have significant financial problems at the same time that our markets are starting to crumble.

Not good.

And don’t forget about Europe. European stocks have had a very, very rough month so far…

The narrow EuroStoxx 50 index is now at its lowest in over seven months (-5.4% year-to-date and -12.5% from its highs in May) and the broader EuroStoxx 600 is also flailing lower. The European bank stocks pushed down to their lowest in almost 10 months and are now in bear market territory – down 22.5% from their highs. Spain and Italy are now testing their lowest level in 9 months.

So are the central banks of the world going to swoop in and rescue the financial markets from the brink of disaster?

At this point it does not appear likely.

As I have written about previously, the Bank for International Settlements is the central bank for central banks, and it has a tremendous amount of influence over central bank policy all over the planet.

The other day, the general manager of the Bank for International Settlements, Jaime Caruana, gave a speech entitled “Making the most of borrowed time“. In that speech, he made it clear that the era of extraordinary central bank intervention was coming to an end. The following is one short excerpt from that speech…

“Ours is a call for acting responsibly now to strengthen growth and avoid even costlier adjustment down the road. And it is a call for recognizing that returning to stability and prosperity is a shared responsibility. Monetary policy has done its part. Recovery now calls for a different policy mix – with more emphasis on strengthening economic flexibility and dynamism and stabilizing public finances.”

Monetary policy has done its part?

That sounds pretty firm.

And if you read the entire speech, you will see that Caruana makes it clear that he believes that it is time for the financial markets to stand on their own.

But will they be able to?

As I wrote about yesterday, the U.S. financial system is a massive Ponzi scheme that is on the verge of imploding. Unprecedented intervention by the Federal Reserve has helped to prop it up for the last couple of years, and there is a lot of fear in the financial world about what is going to happen once that unprecedented intervention is gone.

So what happens next?

Well, nobody knows for sure, but one thing seems certain. The last half of 2013 is shaping up to be very, very interesting.