Is a financial market crash in the works?

 

FINANCIAL market volatility is expected to increase significantly as US financing requirements exert further upward pressure on bond yields.

There is even warning of a possible crash.

“The pressure on the bond market has already caused yields of 10-year US Treasuries to surpass its resistance of 2.6%.

“In the last fiscal year, the US deficit had already reached US$666bil, its largest since 2013. The Trump administration is reported to be selling US$66bil worth of long-term debt in the first quarter to fill the financing gap.

“This will further exert upward pressure on bond yields,” said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.

Bond yields and prices move in opposite directions; rising yields indicate negative market conditions.

Stock markets plunged and bond yields soared last Friday after US data, showing the strongest annual wage growth since 2009, rattled investors who fear that rising inflation would lead to more rate hikes than expected, according to Reuters.

“Trump’s military spending and tax cuts, plus the Fed ending the last bits of quantitative easing (QE), all point to the fact that Treasury issuances are going to be huge.

“This is particularly at a time when a big buyer, that is, the Fed, is withdrawing from the market. So interest rates just have to climb. “If wage pressures climb, like I think they will, the Fed will have its hands tied with monetary easing,” said Pong.

The US Fed kept interest rates unchanged last Wednesday but said inflation would likely rise this year, said Reuters.

“The implications of a bigger budget deficit and debt are rising long-term rates and price inflation. US infrastructure spending, if implemented as planned, will boost economic growth via the multiplier effect.

“Sustained US growth bodes well for the global economy, and Asian exports. The trillion dollar infrastructure spending will put pressure on the US budget deficit and national debt,” said Lee Heng Guie, executive director, Socio Economic Research Centre.

Hot on the heels of tax cuts, Trump had unveiled a US$1.5 trillion infrastructure spending.

“These are intended as positive moves but the funding for the huge deficit that it implies, has not been quite thought out. Spiking Treasury yields is evidence that money does not grow on trees.

“Central banks will probably be forced back into QE; they are effectively locked into a game of QE infinity. Each time they attempt to exit QE, a crisis breaks out,” said Pong.

“I worry about a spell of very high and spiralling inflation. With QE, there is no limit to the amount of US dollars and other reserve currencies (that can be minted) to buy up physical resources especially commodities.

“By pouring more and more cheaply minted money into exploration and production of commodities, we have deferred the arrival of the day of reckoning,” said Pong.

Huge new commodities supplies will keep commodities prices low; this capacity to produce consumer goods will mean a hugely competitive industry producing goods at low prices so that low interest rates can be justified.

“It is a truly vicious cycle,” said Pong.

Legendary investor Jim Rogers had predicted, in his interview with “The Bottom Line” in the middle of last year, that a market crash that is going to be “the worst in your lifetime,” will likely happen this year.

“In 2008, we had a problem because of debt... that debt is nothing compared to what’s happening now. In 2008, the Chinese had a lot of money saved for a rainy day.

“It started raining. They started spending the money. Now, even the Chinese have debt, and the debt is much higher.

“The Fed... the balance sheet is up over five times since 2008,” Rogers was quoted as saying. If this drop (the Dow fell 666 points last Friday) is (the crash Rogers was predicting), it is only the first instalment. That is why we should be afraid... very afraid,” said Pong.

There are concerns on the effects of the US tax cuts which is reminiscent of the Ronald Reagan era in the 1980s.

This “supply side” policy is based on the argument that a tax cut will provide enough stimulus where revenue growth will eventually increase and make up for the initial loss.

“Reagan tried this but the budget deficit swelled to 5% of gross domestic product in 1983, from 2% in 1980.

“The pressure on the deficit lead to a surge in rates and yields on US Treasuries spiked by 400 basis points in the late 1980s,” said Zahidi.

Columnist Yap Leng Kuen wonders if it is a ‘healthy correction’ or start of a crash.