Investor Larry McDonald said don't think the worst moment has passed.
As interest rates rise rapidly, the stock market continues to fall, and Federal Reserve will launch a policy fulcrum. Both may continue.
McDonald, founder of The Bear Traps Report and author of The Great Failure of Common Sense, which describes the bankruptcy of Lehman Brothers in 2008, expects more turbulence in the bond market, partly because "the world today has $50 trillion more debt than in 2018." This will hurt the stock market.
The bond market dwarfs the stock market – both have fallen this year, although the rise in interest rates is even worse for bond investors due to the inverse relationship between interest rates (yield rate) and bond prices.
About 600 institutional investors from 23 countries participated in the chat on the bear market trap website. In an interview, McDonald said the consensus among these fund managers is that "things are breaking down" and the Fed will have to make policy changes soon.
In response to the turmoil in the UK bond market, McDonald said government bonds with coupon rates of 0.5% maturing in 2061 were trading at 97 cents last December and 58 cents in August, with trading as low as 24 cents in recent weeks.
When asked if institutional investors could simply hold these bonds to avoid book losses, he said that some institutional investors were forced to sell and bear huge losses due to the margin requirement for derivative contracts.
Investors have not seen financial statements that reflect these losses - these losses have occurred too late. Write-downs in bond valuations and bookkeeping of some of these losses will harm the bottom-line performance of bank and other institutional fund managers.
McDonald said interest rates don't have to be close to the 1994 or 1995 levels anymore — as you see in the first chart — wreak havoc because “there are a lot of low-interest notes in the world today,” he said. “So when yields rise, it is much more disruptive than the previous central bank tightening cycle,” he said.
This seems to be the worst loss, but bond yields may still move higher.
Goldman Sachs strategists warned customers when they released their next Consumer Price Index report on October 13 to not expect changes in Federal Reserve policies, which have raised the federal funds rate by 0.75% three times in a row, reaching the current target range of 3.00% to 3.25%.
Federal Open Market Committee (Federal Open Market Committee) has also been pushing up long-term interest rates by reducing its U.S. Treasury portfolio. After reducing these holdings by $30 billion per month in June, July and August, the Fed began to reduce its monthly decline by $60 billion in September. After three consecutive months of cuts in federal agency debt and institutional mortgage-backed securities , the Federal Reserve began reducing its holdings of $35 billion a month in September.
On October 11, BCA Research bond market analysts led by Ryan Swift wrote in a client note that they continue to expect the Fed to not suspend the tightening cycle until the first or second quarter of 2023. They also expect the default rate of high-yield (or junk) bonds to rise from the current 1.5% to 5%. The next Federal Open Market Committee meeting will be held on November 1-2, and a policy announcement will be issued on November 2.
MacDonald said if the Fed raises the federal funds rate by another 100 basis points and continues to cut the balance sheet at current levels, "they will crash the market."
pivots may not prevent pain
MacDonald expects the Fed to be worried enough about the market's response to its currency tightening, "retreating in the next three weeks" and announced a slight increase in the federal funds rate by 0.50% in November, "and then stop."
