Broker Check

Interest Rate Frenzy

March 09, 2020

As of the writing of this article the world-wide numbers on the Corona Virus aren’t pretty. The total number infected has risen to 100,034 and the death total stands at 3,825. Schools are closing, companies are cancelling travel plans, families are cancelling vacation plans and some tourist-type businesses have nearly ground to a halt. Supermarkets in the U.S. are reporting customers stocking up on essentials and some shelves are empty.

Financial markets are swooning on all this news. The major U.S. stock indexes have entered “correction” territory, selling off their highs at an alarming pace. Commodity markets are selling off hard as it seems the biggest buyer of commodities, China, will be on the sidelines while they try to piece their economy back together.

U.S. treasury markets are rocketing higher as investors clamber for safety. Interest rates have completely collapsed, and the 10-year U.S. treasury is yielding about .5%. Yes, you read that right one half of one percent for ten years…

The price of the 10-year has rocketed as you can see, and the yield has completely collapsed. So, the question now is how bad can this get?  Is this virus situation really going to push the world economy over into a recession?

Everyone paying attention to the economic situation in the world economy knows that there is too much debt in the world’s monetary system(s). As interest rates have been so low for so long – decades - trillions of $ of debt have been rung up. We have mentioned several times in this weekly post that one of the things that we worry could start a domino effect in bad debt defaults is a hard selloff in the price of crude oil. The problem is that hundreds of billions of dollars have been loaned to risky oil companies. Really low crude oil prices could break these companies and defaults on corporate debt are inevitable. Any serious issue in our credit markets we worry could spill over into less risky debt and simply start a domino effect of panic. Well the price of crude oil is cratering. This is a serious development and more corporate debt defaults in the energy complex are inevitable – and probably very soon. Certainly, we don’t know if that will initiate panic anywhere else, but at a time when all the financial markets are so shaky, we feel this needs to be watched closely.

Another indicator that we have had on our radar is the “high yield” corporate bond market. (This is where the low crude oil prices would manifest in selloffs in energy company bonds.) High yield is of course a marketing term for junk bonds, but we watch this because it is riskier debt that investors have piled into because of the higher interest rate yield. Presumably this is one of the first asset classes that will get hit hard if the credit cycle and hence the total economy is truly turning south. Here is a chart of one of the largest junk bond funds.

That is a violent selloff and deserves attention – again this is something that could spill over into higher grade corporate bond issues. The violence to the downside will undoubtedly get overdone. Last week we mentioned that we didn’t think we had seen the low of the pullback in stocks. From here we believe the near-term selloff is close to done. The central banker around the world will be out in force pouring more money on the system in order to keep it intact. From there we will have to see how the market and the world economy reacts – and of course we will have to follow the spread of the corona virus.  Stay tuned…

Regards and good investing!