U.S. Economic/Financial News
Bond Market Faces Huge 'Shock' if Fed Hikes Rates
The highly leveraged bond market faces a massive "shock" if the Fed rapidly hikes interest rates, warned Business Week in its April 26 issue, in a feature on the terror spreading through financial markets. "Jittery" traders in the multi-trillion-dollar bond market, some of whom are dumping bonds to cut the losses that were triggered by the phony jobs report on April 2, are "all dreading" the release of the next jobs report on May 7, which may trigger another sharp sell-off.
There is intense "anxiety" about how soon the Fed will raise short-term interest rates, Business Week said, because the bond market is "more leveraged and more hooked on cheap Fed financing than it has been in at least a decade." A rate hike would spell the end of the very profitable "carry trade," in which hedge funds, banks, and Wall Street dealers borrow money at low overnight rates and use the cash to buy bonds with yields that are higher than borrowing costs.
Bond market bets are leveraged "more than ever," BW said. Net borrowings by Treasury securities dealers, such as big Wall Street banks and securities firms, have doubled over the past three years, up to nearly $800 billion. Hedge funds and offshore tax havens have doubled purchases of bonds. Some hedge funds are so leveraged, the Wall Street Journal noted April 19, they have been using more than $25 of borrowed money for each $1 of their own to make trades.
Worse, the bond market is twice as leveraged as it was just in 1994, the "worst year of losses ever" for bond investors. Then, dramatic price changes in interest-rate derivatives sunk several hedge funds and forced the wealthy Orange County, Calif. into bankruptcy.
A rapid interest-rate hike, by not giving bond investors time to unwind their positions, would cause "violent selling that could roil trading firms, rattle bank lending, and paralyze borrowers, from corporations to home buyers." For example, the interest-rate swaps market could become illiquid, the WSJ warned, endangering non-financial companies (GE, GM, Deere) that depend on their financial subsidiaries for at least 50% of their profits.
Greenspan Hint Sends Bond Prices Tumbling
Delphic Fed chairman Alan "Dracula" Greenspan, in testimony to the Senate Banking Committee April 20, said the risk of deflation had essentially disappeared, while the "strong" U.S. banking system would be able to adjust to higher borrowing costs. Bond investors interpreted his comments as suggesting the Fed is prepared to raise soon its key short-term interest rate. The banking sector "is adequately managing its interest rate exposure," he said in the prepared text. "Many banks indicate that they now either are interest-rate neutral or are positioned to benefit from rising rates." While admitting that "some banks would undoubtedly be hurt by rising rates," Greenspan insisted that the banking system appears "not to have exposed itself to undue risk." The economy is "clearly coming back," he opined, adding that the threat of deflation was "no longer an issue."
In response, U.S. Treasury prices fell, sending short-term yields up to their highest level in 18 months. The yield on the two-year note jumped 14 basis points to its highest level since October 2002. Also, the yield on the benchmark 10-year note rose seven basis points to 4.47%, the highest closing level since September.
Fed Governors Debate Rate Hike as Bonds Fall
Richmond Federal Reserve governor Alfred Broaddus became the fourth Fed governor to take a public position for or against interest-rate hikes since "Bush's April 2"the President's April Foolish declaration of victory on the economic front. The public statements, reported in USA Today April 19, indicate a fight in the Fed over whether or not to go for near-term rate hikes. Broaddus said he did not think an immediate increase in rates was needed, joining Ben "Bubbles" Bernanke who had denounced the idea. Governors Poole of St. Louis and Parry of San Francisco have come out for rate hikes.
Meanwhile, ahead of Greenspin's testimony to the Senate Banking Committee, Dallas Fed president Robert McAteer said the central bank could raise interest rates and still stimulate the economy, Dow Jones reported April 20. The current 1% Fed funds rate, he told Cable News Network, "could be a bit higher, and policy would still be very accommodative." Likewise, Philadelphia Fed president Anthony Santomero said interest rates "will begin returning to a more neutral stance," but "only slowly." Both officials are nonvoting members of the Fed's Open Market Committee, which sets interest rates.
The bond markets, meanwhile, are continuing to fall two and a half weeks after April 2, with Treasury bond rates having risen almost 0.8% since last month. Treasury "confidence indices" point to further falls expected.
Fannie Mae Delays Release of Quarterly Balance Sheet
Fannie Mae has postponed the release of quarterly balance sheet and future derivatives losses, disclosures that were expected to be included with its quarterly earnings statement, issued April 19. Fannie, whose accounting practices are under investigation by its Federal regulator OFHEO, announced it would delay reporting the future impact of most derivatives on earnings and total stockholders' equity, until its SEC filing on May 10after the Fed's Open Market Committee meets May 4. A Fannie Mae official said the balance sheet is increasingly complicated and the company wants to do "as much checking as possible" of the data.
The three-week delay, according to some analysts, suggests Fannie has "something to hide," such as understated write-downs in its $8-billion portfolio of securities backed by mobile-home loansits trailer trash.
LAX Suffers Second Blackout in Eight Days
Los Angeles International Airport suffered power outages April 19, causing some buildings to go without electricity for nearly two hours, the second such lapse in only eight days. Some buildings were without power for two hours, although, thanks to back-up batteries, no flights were disrupted. The outage started at 11:31 a.m., causing lights to flicker in the airport, and some buildings remained without power until 1:19 p.m.
Bob Marks, regional Vice President of the National Air Traffic Controllers Association remarked, in an understatement: "This sure seems like a fragile power infrastructure.
|