Writing in the Corner, Veronique de Rugy notes the complaints about the Fed’s rate rises but comments that the increases have, in fact, been “mild” (at least so far). And, looking at them from a historical perspective, she’s right.
The problem is that, so far as interest rates are concerned, we have been living through an anomalous time. A Fed funds rate of zero? Ridiculous, except, perhaps briefly, in the case of an emergency — break the glass and all that. But ultra-low rates prevailed for the better part of a decade. In Veronique’s view, “we are barely getting back into the sanity zone” even now. That’s surely true, but, as she observes, those who got “high” on those very low rates are now going through withdrawal, and not enjoying it one bit.
Unfortunately, the pain won’t end any time soon. Bouts of inflation typically take longer to be driven out of the system than is widely imagined, and the Fed’s interest-rate policy will reflect that. In this instance, and as I have mentioned before, we also face the woes that will follow the de-rating (to use a gentle word) of investments made at a price that made sense when money was cheap, but no longer do. Something similar can be said about leverage.
There is plenty of room to disagree about how much further this de-rating has to go. One of the reasons for that disagreement is that ultra-low rates took us into uncharted territory. The Financial Times quotes from a letter reportedly written by hedge-fund manager Paul Singer to his clients, in which Singer refers to an “extraordinary” set of financial extremes that have “made possible a set of outcomes that would be at or beyond the boundaries of the entire post-WWII period.”
Those outcomes are unlikely to be pleasant.
One of the perils of a great unwinding is that it can — and quite probably will — unwind in unexpected ways and, as it does, uncover weaknesses in the financial system that had been overlooked or underrated. Thus the recent meltdown in U.K. government bonds was made far worse by the way that pension fund managers had been trying to boost the return on their low-yielding gilts with derivatives, a risk that had been largely shrugged off.
In recent posts, I have mentioned or reported areas of concern including private equity and debt, Italian government bonds, U.S. corporate debt, housing, and the shadow-banking sector. Singer reportedly mentioned banks’ losses on bridge financings (after what were supposed to be temporary loans turn out not to be so temporary), write-downs on collateralized loan obligations, and leveraged private equity. So those all need adding to the list. Office property, I reckon, is another obvious worry.
Rough road ahead . . .