Interest Rates Are Worth Watching
Get ready for interest rate volatility. A financial crisis could be brewing.
Why be so pessimistic?
You see, at the moment, interest rates are becoming very unpredictable.
Not too long ago, economists were expecting rates to go higher. And a lot of them were very wrong.
In recent months, the Federal Reserve has actually slashed its benchmark interest rates by 0.25%. But based on the bonds market, it’s not enough. The Fed will need to do more.
Look at the chart below, which plots yields on 30-year U.S. bonds over the past 50 years:
Chart courtesy of StockCharts.com
Just recently, yields on long-term U.S. bonds hit a historical low. That essentially means that the Fed may not be done raising rates just yet.
Keep in mind that yields on these bonds are much lower than what they were in the midst of the financial crisis of 2008-2009. This implies that the Federal Reserve may be taking its benchmark interest rates lower than what it had set after the previous crisis. So this time around, interest rates could go below zero.
Why Worry About a Financial Crisis?
A financial crisis occurs when the value of assets goes down mainly due to problems in the financial sector. In 2008-2009, banks took on risky bets and ran out of money, causing them to seek assistance.
Over the past few years, American banks have been fairly strong because they got tons of help from the government and the Federal Reserve. Their credit quality has improved as well.
However, they may have also gotten little sidetracked in the midst of everything.
There’s one thing they did and no one is talking about it. As volatility in interest rates increases, big banks in the U.S. could get into a lot of trouble.
$149.2-Trillion Ticking Time Bomb
I believe the interest rate derivatives at U.S. banks could be worth watching closely.
Consider that at the end of the first quarter of 2019, U.S. banks had $149.2 trillion notional worth of interest rates derivatives. (Source: “First Quarter 2019: Quarterly Report on Bank Trading and Derivatives Activities,” Office of the Comptroller of the Currency, last accessed August 15, 2019.)
Even just 10% of this notional amount is a lot of money. Were it affected, it could have ripple effects across the financial sector—perhaps even a total bank failure.
Keep a close watch on what’s happening. Should a financial crisis occur, things could turn ugly very quickly, including a decline in value for stocks and other assets.