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Spike in 3-month Libor is bad news for borrowers

dubai - Homeowners should expect their monthly payments to spike higher in the next 12 months

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I had projected a bloodbath in the US Treasury bond market since late 2016, when it was obvious that Trump's tax reform would double the US budget deficit at the same time as the Federal Reserve prepared to "normalise" or shrink its balance sheet by $470 billion. Fiscal stimulus is often a policy ballast amid a depression, as in the early 1980s or 2009, not when US economic growth is accelerating and the unemployment rate is at its lowest in 25 years. The bloodbath in the bond market has now begun, as the yield on the US 10-year Treasury note risen above 2.65 per cent last week. Yields on Uncle Sam's 5- and 10-year debt have violated post Desert Storm downtrend lines on the charts. Debt trading maestro Bill Gross views a 2.60 per cent yield on the ten-year US Treasury note as marking the start of a new bond bear market. This began last week and will change the world, as Lehman's failure did that fateful September in 2008.

The world is in the first synchronised global economic recovery since the 2008 global financial crisis. Wage inflation has begun to creep higher, despite the deflationary thrust of technology and global supply chains. The Fed, Bank of England and even the ECB will replace printing money with quantitative tightening. Dr Copper, a barometer of industrial cyclical demand, rose 32 per cent. The US baby boom generation, the biggest in history, has begun its peak retirement years. The US Treasury bond yield curve is the flattish in a decade. Inflation will resurrect the bond vigilantes as the regime change in the Federal Reserve in March increases global angst on long dated debt. It is entirely possible that rising inflation forces four or even five Fed interest rate hikes in 2018.

I expect the Fed Funds rate to be 2.5 per cent in the next twelve months. This is the overnight interbank borrowing rate targeted by the US central bank's Federal Open Markets Committee. The Fed has a dual mandate to optimise jobs consistent with 2 per cent inflation (price stability). The Fed has reached the limits of its dual mandate as the US economic supertanker creates 200,000 new jobs each month while services inflation in the CPI index is 3 per cent (though goods is flat). This means the yield on the ten-year US Treasury note will rise to 3.2 per cent and lead to a spike in mortgage debt rates across the planet. As post (not revenue neutral) tax reform US economic growth rises above 3 per cent, demand for US Treasuries will fall even as the US budget deficit rises and stimulates more borrowing by Uncle Sam. Chinese, Japanese and Gulf petrodollar recycling demand for US Treasury bonds has now peaked. This means the world is on the eve of a major, secular rise in interest rates. This time the wolf is really here.

I am horrified by the surge in the London Interbank Offered Rate (Libor), the benchmark for literally trillions in floating rate corporate, sovereign, credit card and mortgage debt, since the last FOMC rate hike in December 2017. Libor is the rate at which the world's leading banks lend to each other in the global interbank money markets. Note that the three-month Libor rate was 0.5 per cent in early 2016. It has now spiked to 1.6 per cent as the Planet Forex realises Fed monetary tightening is for real. The three-month Eibor rate has surged to 1.82 per cent as I write. This is bad news for owners of mortgages, sukuks and corporate bonds in the UAE. Since almost all mortgages in the UAE are floating rate, homeowners should expect their monthly payments to spike higher in the next 12 months. Expect heavily leveraged corporates to face financing risks.

US tax reforms, Fed rate hikes and the upticks in global growth and inflation will only accelerate the rate of increase in Libor and credit spreads on $50 trillion in floating rate debt. The cost of capital for every homeowner, corporate borrower and government in the world has spiked higher since last autumn and is destined rise higher.

My call? A disaster in the US junk bond market is inevitable as stressed industries have more than a trillion dollars in speculative debt outstanding. Note retail (Amazon's killer economics) and hospital chain bankruptcies are at a higher rate than in 2008. Regulatory costs are killing specialty pharma. The surge in West Texas crude will not save offshore drillers and clean energy. Get real. Get short.
The writer is is a global equities strategist and fund manager. He can be contacted at: mateinkhalid09@gmail.com.