Washington, DC -- (ReleaseWire) -- 12/21/2015 --In anticipation of the FOMC meeting this week, the markets tumbled: the Dow dropped 582 points, or about 3.3 percent, and the S&P 500 lost 3.9 percent, 79 points. For the S&P, that was the steepest decline since the August 2015 correction. Investors are starting to understand that credit is tightening, as is monetary policy. Earnings are weak, and speculation about the actions of Janet Yellen and the FOMC this week added to the uncertainty. Of course, the FOMC did walk away from their zero interest policy, raising the Federal Funds rate for the first time in nearly a decade by 25 basis points, but will Yellen be able to make it stick? Worldwide, five central banks have raised interest rates since the financial crisis, and all of them were forced to reverse that decision almost as quickly as they made it. This could easily happen in the U.S. as well.
At a point when the markets are starting to sell off for everyone, even this relatively modest hike could create a dangerous situation not only for the Federal Reserve, but for Europe. From 2008, the European Central Bank and the Fed have coordinated monetary policy. When the U.S. Federal Reserve released its discount window documents in 2011, it became crystal clear that most of the funds from the U.S. quantitative easing to actually went to foreign banks located in the European Union. And again, when the European banking system was at its worst in 2012, the Federal Reserve coordinated with the ECB to announce QE3, in an effort again to prop up the European banking system. Across the world, central banks work together to maintain stability in the global financial system, but when things really start getting difficult, they start looking out for their own interests. This is when competitive devaluation of currencies begins.
I believe that the cooperative relationship between the Fed and the ECB may be set to break down. The Euro comprises 56 percent of the basket of currencies against which the dollar is valued, and Europe holds over $9 trillion in U.S. dollar denominated debt, which is called the U.S. dollar carry trade, and the FOMC move to raise interest rates could easily cause fault lines throughout that trade. Investors need to keep an eye on ECB monetary policy in the next months, because their actions carry significant impact to us in the United States.
We really do seem to be in an echo of the '07/'08 crisis, and one that has the potential to be exponentially worse than that event. In 2007, the Bear Stearns High Grade Structured Credit Fund started to show signs of trouble, which eventually led to an emergency loan from the New York Fed than ultimately failed to save the company. Just as Bear Stearns froze redemptions on its credit hedge fund in 2008, two big hedge funds (Third Avenue and Stone Lion Capital) have done the same in the last few weeks. Add that news to the increased volatility resulting from commodity and energy selloffs, and we should be seeing a big red flag for risk assets.
Many of us thought that the 2008 crisis was the worst of a lifetime, but some perspective might adjust that perception. In 2008, the tech bubble was at about $15 trillion, and the housing bubble at $30 trillion. The bond bubble today stands at about $100 trillion, and if you included bond-based derivatives that number soars to $555 trillion. That's trillion, with a "T." The crisis we may be facing stands to be orders of magnitude greater than the last one, and investors should be prepared.
One way to do this is to look at what companies such as Stone Lion are invested in. For instance, bond yields especially on triple-C rated bonds and lower, are soaring, but prices are dropping to rock bottom. This is the reason these funds are putting gates in place to prevent investor redemption: they simply cannot afford to sell at these prices. More specifically, Stone Lion is one of a group of hedge funds aggresively invested in Puerto Rico, and raised $500,000 for that purpose in the last year. Last week, the governor of Puerto Rico, Alejandro García-Padilla, appeared on CNN and flatly stated that the territory simply did not have the cash to manage huge debt payments in January and May, urging Congress to step in quickly in order to avoid a financial and humanitarian crisis that would reflect poorly on America.
With this crisis looming over world financial markets, some of the biggest news of the past two weeks has been the release of COP 21, or the Paris Climate Accord. For two weeks, representatives from 196 countries, nearly the entire world, lived it up in Paris, flying in on private jets and government 747s (no carbon footprint there, right?), in order to produce this 31 page document, which simply contains no binding language, no enforcement provisions. President Obama talks up this "treaty" as if it's a grand solution, but with no teeth, can it possibly be any sort of solution at all? Not to mention that two-thirds of a Senate with which he has at best marginal relations must approve this deal if it is to become any sort of law of the land for the United States. Time after time, climate change has ranked at the bottom of the list of voter priorities, and at a time when retirements, livelihoods, and even the roofs over our heads may be threatened by an imminent and potentially cataclysmic crisis, why are we spending so much time, money, and attention on an issue for which we can't even produce an actionable fix that can bind all the signing parties?
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com.
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
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Dawn Bennett Writes Article, "The Bigger the Bubble..." Regarding the Recent Drop in Markets