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Why Markets Are at Risk from a New Global Financial Crisis

Just as we put the latest Greek debt drama behind us, HiWayFX brings to your attention another looming financial crisis which could be just as bad as the one from 2008.

This is what major financial firms from UBS to Goldman Sachs are warning of, due to major dislocation in world government bond markets and a 54% decline in the price of WTI Crude Oil in the span of 8 months.

Government Bonds

To put it into perspective, the yield on 10-Year US Treasury Notes shows the percent return that investors can expect to receive for loaning money to the United States for a period of 10 years. It us used as a global benchmark for setting interest rates and is considered one of the safest investments around. That rate is currently at 2.02%, up from a recent low of 1.65%.

Now, consider the yields on the counterpart notes from Italy or Spain, two countries which experienced major bond market turmoil in 2012, when their borrowing costs soared as high as 7%. Today, Italy and Spain only have to pay 1.35% and 1.28%, respectively, to borrow money for 10 years.

So what we just said was that it costs 60% more for the US to borrow money than it does for countries on the ‘periphery’ of the Eurozone and that are a fraction of the size of the US economy. What is wrong with this picture?

10-Year US Treasury Yield
Source: Federal Reserve Bank of St. Louis, HiWayFX

The dislocation here is due to something we have been writing about for the past year; namely, the expectations for the Federal Reserve to raise rates in the near future, while Europe (and the rest of the world) are lowering national interest rates to negative territory and engaging in massive quantitative easing. Fundamentally, this puts the US Dollar in an extremely favourable position for the long term. What is scary though, is what will happen when all the governments around the world that have been buying up their own sovereign debt for all these years, have to unwind their massive positions and start to sell. The result could be catastrophic for bond markets of some of the weaker nations.

Oil and Looming Energy Sector Defaults

Once upon a time in the late 90s, there was a big hedge fund called Long-Term Capital Management that blew up spectacularly and took a large chunk of the US economy with it. At the same time, there were two sovereign debt crises, one in 1997 in Asia, and another in 1998 in Russia which saw it default on its debt and devalue the rouble.

Oil, which has lost over half of its value in the last 8 months, could start a cascade of corporate defaults in the energy section, if history repeats itself. Then we would have the perfect storm of sovereign and corporate defaults sending shockwaves through the global economy.

WTI Crude Oil Weekly Chart
Weekly chart of WTI Crude Oil

 

Rising Volatility

Against this backdrop, we’re already seeing huge swings in the price of Treasuries and foreign exchange rates. Spreads in Forex markets have risen and stayed elevated since the Swiss National Bank shocked traders and removed the floor of 1.20 in EUR/CHF. Everyone is on the edge of their seat waiting for the next central bank surprise, and we’re still watching the drama play out ever since Greece got its first bailout in 2010.

It seems that this volatility will be staying with us for the larger part of this year.

Friday, 27 Feb, 2015 / 2:04

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Source : https://www.hiwayfx.com/market-news/why-markets-are-risk-new-global-financial-crisis

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