Black Monday '07
By Adrian Ash
August 22, 2007
Monday this week marked the
biggest move in US bond yields since Black Monday two decades
ago...
DO YOU REMEMBER how inflation was the
investment world's biggest single worry back in...oh...well,
back in June this year?
Anyone snapping up 10-year US Treasury bonds back
then is now looking clever. Very. Ten weeks ago, the 10-year
yield touched a half-decade high of 5.32%. On Monday night in
New York it closed below 4.65%.
That jump in longer-term bond yields equals more
than two baby-steps along the hard stony path of central bankers
stumbling from rate-hiking to rate-cutting as the financial
markets slump. Monday this week in fact marked the biggest cut
in short-term bond market rates since Black Monday 1987.
"Institutional investors added $39.7 billion
to money market funds holding mainly government securities from
Aug. 14 to Aug. 17," reports Bloomberg, highlighting the
switch, "a 12% increase according to Connie Bugbee,
managing editor of the Money Fund Report newsletter in
Westborough, Massachusetts. Assets in funds that may also hold
commercial paper, certificates of deposit and floating-rate
notes fell 2%, or $24.5 billion."
This summer's flood of money into the "safe
haven" safety of government debt has hit a record pace.
Three-month US Treasury bills ended Monday yielding just 3.09%,
down by 0.66% for the day and the sharpest fall since the stock
market crash of October '87. Now the futures market is unanimous
in pricing in a cut in US interest rates next month.
Seven in ten of those bets is gambling on a
"big baby step" from 5.25% to 4.75% in one jump. Will
they get it?
"The problem in the credit market is far from
over," says Kornelius Purps, the beautifully-named
fixed-income strategist at Unicredit Markets & Investment
Banking in Munich. "Yields at the short end are plunging.
Speculation is growing that the Fed will cut in September, if
not before."
Oh really? Oh yes! Only a "calamity"
would cause the Fed to cut rates before its meeting on Sept.
18th, said William Poole, head of the St.Louis Federal Reserve
Bank last Thursday. Even as he spoke, however, the true rate of
interest charged to Wall Street's investment banks by the Fed in
New York had dropped half-a-per-cent BELOW the official target
rate.
Then, the following morning – and just ahead of
the Wall Street open – the Fed slashed its primary discount
rate from 6.25% to 5.75%, urging the biggest commercial banks to
borrow early and often. Paul McCulley at Pimco, the world's
biggest fixed-income investment fund, told Bloomberg yesterday
that the Fed's move "was textbook, beautiful central
banking."
But then, as a man whose funds rise in value when
interest rates fall, he would say that, wouldn't he?
The key to defeating an incipient panic, said
Walter Bagehot in the classic Victorian text Lombard Street, is
to "either shut the bank at once, and say it will not lend
more than it commonly lends, or lend freely, boldly, and so that
the public may feel you mean to go on lending."
Let's be in no doubt. The US Fed means to go on
lending...freely and boldly...just as prescribed. Bill Poole's
calamity has now come to pass, at least in the eyes of Ben
Bernanke and his team at the Federal Reserve in Washington.
Given that you and I can't borrow from the Fed's discount
window, however, what might this calamity mean for us poor
savers, borrowers and investors?
Well, in Europe already this week, financial
companies have failed to refinance all the asset-backed
commercial paper (ABCP) that is now maturing. Forgive the
alphabet soup, but this might just prove important. ABCP
"started modestly as a way for banks to move assets off
their balance sheet," explains The Banker. Financial firms
issue short-term ABCP, and use the cash raised to fund
longer-term investments including mortgages and bonds, Bloomberg
adds.
And yesterday, says Saher Bin Jung – a commercial
paper trader at Commerzbank in London – only around half of
the ABCP notes that matured were re-sold. Data from Dealogic
goes further. It says that 80% of Monday's ABCP issuance failed
to find buyers...nearly $5 billion worth of debt.
Does this matter to you? It might do if you want to
re-mortgage your home, buy a new car, or raise extra funds to
grow your own business any time soon. Even as the US Federal
Reserve – the world's biggest central bank – tries to wind
back the clock on the greatest bubble in debt ever seen, the
financial markets themselves remain choked. ABCP provides a big
chunk of the cash that winds up on Main Street as new home
loans, auto-finance and other end-user loans.
And if Europe's biggest financial firms cannot
refinance their loans, even with bond yields sinking, what hope
for the world's mergers & acquisition frenzy, too?
For larger investors and those retirees lucky
enough to be finished with debt and long only of choice, the
smart move in hindsight seems clear. But maybe it's now been and
gone.
You could have picked up more than 5% yield from
the 10-year US Treasury bond in mid-June. Now yields are
sinking...and the Bernanke Fed is expected to cut its target
interest-rate at its Sept. meeting or before.
If the Fed demurs, bond prices will spike lower –
and any "Bernanke Put" assumed by stock-market
investors will be found to expire worthless. If the Fed does
indeed choose to cut rates, on the other hand, investors in both
bonds and stocks would do well to remember:
Inflation was the investment world's greatest
single concern only 10 weeks ago.
Where to put your money when inflation looms even as
interest-rates fall? To read an in-depth report on how the
Gold
Market really works now, click through to
download this 16-page PDF:
Free
Report: Five Myths of the Gold Market