The US market had its worst week in a month and both the UK, parts of Europe and Hong Kong had their worst week in 8 months. Markets tumbled across many sectors this week as nerves are on edge with Global Debt and a risk of contagion across markets. Is this the long awaited ‘bond run’ that we have been warning you about? Maybe, maybe not. Fears are rising as US job employement figures increased even further in September.
So why did the UK fall 2.56%, France 2,44%, Hong Kong 4.38% and the US tumble 2% in two days?
We will take you through our thoughts and logic on why stock markets are worried about interest rates and the bond market:
- Global debt in US, China, Europe, Japan are at record levels.
- Spectacular jobs results and lower unemployment in the US = more people working = more people spending = economy overheating = inflation rises.
- The Fear: US Federal Reserve will increase interest rates even faster than expected to curb inflation.
- If interest rates rise, then equally Government borrowing will become more expensive i.e. Bond and Gilt yields rise i.e. it costs countries more to borrow e.g. if governments were only paying 2% pa now and then must offer say 4% pa.
- Impact: What happens to existing bonds and gilts that pensions, investors, banks, insurance companies own? In the above example, if you bought 2% fixed interest Treasury stock for £100,000 last year. i.e. you now have a secure income of £2,000 pa.
- Interest rates then rise to 4%. What could you sell your £100,000 bond paying £2,000pa. for? Answer: £50,000. A new investor will only pay £50,000 for a £100,000 Treasury Bond paying £2,000pa. £2,000 pa income on a £50,000 investment = 4% (the new market rate). Your bond has crashed in value by 50% (yes, we know this is an extreme example).
- Dilemma: Governments are many trillions of £/$/€/ ¥ in debt i.e. investment institutions, investors and speculators hold trillions of £/$/€/ ¥ government debt as investments.
- Interest rate rises could mean huge 'bond' losses meaning people sell off their government bonds.
- This would be a 'Bond Run' which could lead to a bond market crash.
- Investment institutions, investors and speculators making huge losses in the bond market then start selling equities i.e. stock market investments to cover their losses i.e. a stock market correction or crash.
This happened in 1987 (Black Monday), it happened in 2008 (Credit Crunch). It will happen again. Global debt is bigger than it was 10 years ago. US debt is double what it was 10 years ago. Toxic debt is back again hence the nervousness and falls in markets this week.
Add to this, Italy in trouble for Europe and in the UK speculation is increasing, with the Irish suggesting they will accept Theresa May’s solution to the Irish Border makes a Brexit deal more likely.
- Result: Confidence in the future of the British economy means the £ strengthens. UK companies earning profits overseas means lower profits in sterling terms when they bring those $/€ profits back to the UK meaning FTSE 100 falls. Hence the FTSE 100 having its worst week in 8 months with a combination of stronger £ and concerns about the gilt/bond market.