Around the world, central banks are raising interest rates at the fastest clip in at least 40 years, stressing some markets to the point of cracking, according to The Wall Street Journal.

Corporate bonded debt is showing signs of distress, the WSJ noted, and which we reported in “OECD Warns About Corporate Debt” (25 Feb 2020), “Corporate Debt Bomb is Ticking” (4 Aug 2020), “Money Dries Up for Corporate Bond Issues” (19 Jul 2022) and “Junk Bond Defaults Rising” (13 Sep 2022), among other stories.

When rates are low, investors often borrow cheap money to make investments that offer higher returns. If the investments fail to deliver, the amount of money lost is minimized by the rock-bottom cost of borrowing it.

Years of interest rates held near, or below, zero encouraged “risk-taking, complacency, and leverage,” the WSJ said, as central banks bought trillions’ worth of government bonds to make cheap money available and keep markets lubricated.

For example, the U.S. Federal Reserve dropped its key federal funds rate below 3 percent in early 2008 and left it there, training borrowers and speculators that rock-bottom interest rates were a permanent fixture.

Until then, rates below 4 percent were a rarity except in the aftermath of the September 11 terrorist attacks.

As a result, corporate debt grew from a size equal to 40 percent of the U.S. economy to 50 percent, an increase in the debt load of 20 percent.

Now that interest rates are rising, players in the debt market face massive losses.

For example, Bank of America, Credit Suisse, and Goldman Sachs are poised to lose $500 million on a leveraged buyout of Citrix Systems. The bonds financing the deal had to be sold at a drastic discount after interest rates began to rise, leaving the underwriters to eat the loss.

Credit Suisse’s stock price slumped 18 percent as a result.

The total bonded debt of low- and middle-income countries rose 6.9 percent in 2021 to a record $9.3 trillion, according to the World Bank.

Those nations owe a collective $86 billion in payments on dollar bonds coming due by the end of 2023.

Many of those nations are starting to buckle as a result.

Sri Lanka and Zambia already have defaulted on their debts, with at least a dozen more countries on the brink, according to the International Monetary Fund. 

For more details about developing economies’ plight, see “Strong Dollar Means Weakness Among Emerging Nations” in this issue.

“Alarm bells are ringing most for developing countries, many of which are edging closer to debt default,” the United Nations said in a 3 October statement urging the U.S. Federal Reserve and other central banks to pause rate hikes.

The Fed is “attentive” to those vulnerabilities and aware that they “could be exacerbated by the advent of additional adverse shocks,” vice-chair Lael Brainard said in a late September speech. Nevertheless, the central bank will continue to raise rates aggressively until U.S. inflation is under control, she vowed.

Even pension funds, usually islands of relative stability during economic turmoil, have not been immune to the pressure of higher rates, as recent events in Britain have shown.

After their new government slashed a variety of taxes and set out to borrow more than £72 billion to fund household energy subsidies, the Bank of England jumped into the market to buy billions’ worth of government bonds to keep bond yields from crashing.

Pension funds are obligated to pay benefits at a steady rate. Many invest their capital in bonds because bonds tend to be safe and steady.

However, when the U.K. government announced plans to issue tens of billions in new bonds, yields crashed. Bond yields typically fall as the supply of bonds increases.

Pension funds faced losses and even margin calls and began selling assets, including more bonds, to make up losses.

The British bond debacle resonated through the world’s markets.

U.S. pension funds managed by brokerage Willis Towers Watson were forced to put up tens of millions of dollars in collateral to satisfy margin calls, according to the WSJ.

Many U.S. pension funds faced margin calls because they invested in derivatives instead of bonds. Derivatives promised higher returns during an era of rock-bottom interest rates and as long as rates didn’t budge, all was well.

The extra selling to cover losses drove yields even higher in a “liquidation spiral,” the WSJ said. 

The scenario raised the specter of past bond market debacles, including the 1994 bond sell-off that bankrupted Orange County, Cal., Russia’s 1998 default, and the Great Recession of 2007.

TREND FORECAST: Rising interest rates will continue to put emerging markets under extreme pressure, as we have detailed in articles such as “Emerging Markets Submerging” (9 Nov 2021), “Investors Flee Emerging Markets” (14 Dec 2021), and “Emerging Markets Diving Into Debt Default” (12 Jul 2022). 

Many of the nations piled up dollar-denominated debt to pay the costs of caring for their citizens during the COVID era and to keep their economies afloat.

The dollar’s value has been rising relentlessly for months, sucking value out of the currencies of developing economies, which now have to spend more of their own currencies to buy enough dollars to service their debt.

As we have long forecast, the deeper the emerging market economies sink, the greater the New World Disorder as people across the globe take to the street in protest of lack of basic living standards, government corruption, crime and violence. 

This will in turn escalate the refugee crisis as people flee for safe haven nations. Thus, the greater the refugee crisis, the more populist, anti-immigration political movements will gain strength as they take down establishment parties.

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