Michael Lewitt is one of my favorite credit analysts. If I want to know what is happening in the credit markets, one of my first calls is to Michael. He has been doing deep dives into some rather esoteric markets as well as traditional bonds over the course of his career, and he really understands what is happening under the surface.
In the latest issue of The Credit Strategist, which Michael has given me special permission to pass on to you as today's Outside the Box, he gets our attention right off the bat by comparing the recent big move in the benchmark 10-year Treasury yield to a comparable two-month move in 1994, a year that, as he says, was "generally viewed as Armageddon for bond investors." But in percentage terms, the 1994 move was only 20% over that period while the recent move was 40%.
And what caused that move? Ben Bernanke blinked, that's all. It's high time, says Michael, for investors to prepare their portfolios for the eventual termination of the Fed's monetary fun and games, since:
The comparison between the recent interest rate spike and 1994 underlines just how Fed-dependent markets have become and how incredibly difficult it is going to be for Mr. Bernanke and his colleagues to alter policy without causing serious market dislocations.
Bernanke is creating the conditions for a violent market reversal. As I wrote last month (“Delusions of Stability”), the dependence of markets on the continued beneficence of the Federal Reserve is profoundly unhealthy.
Then Michael takes us straight into the nitty-gritty of how to put in protection. Read and learn – then act while the acting is good.
The Mirror CracksBy Michael E. Lewitt
“Life invests itself with inevitable conditions, which the unwise seek to dodge, which one and another brags that he does not know, that they do not touch him; but the brag is on his lips, the conditions are in his soul. If he escapes them in one part they attack him in another more vital part. If he has escaped them in form and in the appearance, it is because he has resisted his life and fled from himself, and the retribution is so much death.”
– Ralph Waldo Emerson
The financial markets have now seen what a world without quantitative easing is going to look like, and they don’t like what they see one bit. In fact, the mere possibility of an end to the Federal Reserve’s monetary experiment sent credit markets to some of their biggest losses in recent history both in absolute and percentage terms. All of these losses were triggered by a move in the benchmark 10-year Treasury yield from a low of 1.63% on May 2 to a high of 2.66% just a few days before ending the quarter at 2.49%. ISI Group has done some great work placing this move in context. In 1994, a year generally viewed as Armageddon for bond investors, the 10-year Treasury only increased by 90 basis points during a comparable 2-month period that started a sustained increase in rates. Moreover, in percentage terms, the 1994 move was only 20% over that period while the current move was 40%.
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