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ALBERT EDWARDS: The US Fed is about to cause a bond market 'bloodbath'

Door hell craterWikimedia CommonsThe ‘Door to Hell’ Turkmenistan, Darvaza

SocGen Strategist Albert Edwards says higher interest rates will trigger a 1994-style “bloodbath” in the bond market.

Markets are pricing in a 100% probability that the Fed will raise its benchmark rate when it meets from March 14-15. The Fed’s most recent projection for the fed funds rate, which will be updated at the meeting, showed that it could hike as many as three times this year.

In a note on Thursday, Edwards recalled that prior to 1994, markets were expecting interest rates to increase, much like today. After the Fed initially raised rates, the two-year note yield, which moves inversely to its price, jumped about 50 basis points.

“Accelerated Fed rate hikes will cause tremors in the Treasury bond markets, forcing rates up, most especially in the 2 year — just like 1994,” Edwards wrote.

That year, bondholders lost over $US1 trillion.

Screen Shot 2017 03 09 at 8.07.22 AMSocGen

While short-term rates slowly rose under former Fed Chairman Alan Greenspan, long-term rates spiked as markets feared faster inflation and successive rate hikes.

The Fed has said it would continue to raise interest rates if the economic data remains positive. If it hikes rates thrice this year, that would be the fastest pace of hikes in this economic cycle.

As growth indicators such as manufacturing surveys improved last year, bond yields rose and then spiked after President Donald Trump’s election brought the possibility of faster growth and inflation in the US.

But Edwards, who wrote tongue-in-cheek that he would be eligible for a “most dogged bear” Oscar if there was one, sees an eventual reversal that would be caused by a global recession. He said this recession would drive the US 10-year yield below zero, which has already happened to bonds of the same maturity in Germany and Japan:

“I believe the US Fed has created another massive credit bubble that will, when it bursts, lay the global economy very low indeed. Combine this with the problems of a Chinese economy dependent on increasingly ineffective injections of credit to produce increasingly pedestrian GDP growth and you have a right global mess. The 2007/8 Global Financial Crisis will look like a soft-landing when the Fed blows this sucker sky high. The seeds for that debacle have already been sown with the Fed having presided over one of the biggest corporate credit bubbles in US history. All that is needed now is for the Fed to sprinkle life-giving rate hikes onto these, as yet dormant, seeds of destruction.”

Edwards said he thinks the 35-year-old bond bull market is intact, unlike many other strategists. The 10-year yield could rise to as high as 3.25% and the bull market would remain in place, he estimated based on the trend.

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