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Global credit markets showing signs of danger

  • The 12-month Libor is hovering at nearly 2.7 percent and has been rising steadily all year.
  • As money bolted from the stock market late Tuesday, it flowed into the 10-year Treasury note, knocking the yield down to 2.78 percent.
  • Comparing the 10-year yield to the two-year Treasury yield shows a yield curve that has flattened to 51 basis points on Tuesday, a tick above the lowest level of the year.
Caution tape outside the New York Stock Exchange in New York on Jan. 23rd, 2018.
Adam Jeffery | CNBC
Caution tape outside the New York Stock Exchange in New York on Jan. 23rd, 2018.

Is there something rotten in the state of Denmark, or anywhere else in the world for that matter?

While the stock market is clearly showing lingering signs of concern about tariffs and trade wars, looming hot wars and potential privacy wars, the global interest rate markets are also beginning to show worrisome signs of strain.

Often, when we have seen dislocations in the global credit markets, it has been indicative of a looming, but unexplained, economic or market issue.

Consider, as I mentioned a week ago on CNBC, the recent spike in U.S. dollar-based Libor, a key global interest rate on which many loans, from corporate to personal, are based. It stands for the London Interbank Offered Rate.

Like the Federal Funds rate here in the U.S., Libor is, and has been, quite sensitive to liquidity shortages and financial stresses in the world money markets over the years.

Right now, the 12-month Libor hovers at nearly 2.7 percent, and has been rising steadily all year. As yet, no one has offered a satisfactory explanation for its persistent rise, at least that I know of.

When accompanied with a flattening of the U.S. yield curve, and a widening of credit spreads, we could be getting some nascent warning signs of distress somewhere in global financial markets.

The source of that stress is not yet clear. But the markets are worried about something.

As money bolted from the stock market late Tuesday, it flowed into the 10-year Treasury note, knocking the yield down to 2.78 percent. Price moves inversely to yield.

Comparing the 10-year yield with the two-year Treasury yield shows a yield curve that flattened to 51 basis points on Tuesday, or just over a half a percentage point, a tick above the lowest level of the year.

In addition, December Fed Fund futures have rallied of late, moving up in price and down in yield, suggesting that bond traders are beginning to doubt that the Fed will aggressively raise interest rates this year.

Kathy Jones, bond market strategist at Charles Schwab, noted this week, that the effective Fed Funds rate, now at 1.7 percent, after last week's rate hike from the Fed, is above the prevailing inflation rate.

That means that, for the first time since the financial crisis, Fed policy is more restrictive than accommodative which, explains, in part, why stocks and bonds have become so jittery.

Tighter policy could lead to slowing growth, assuming that recent tax cuts, budget increases and deregulation fail to stimulate the economy as much as forecast.

And, we've already seen estimates for first quarter GDP revised to below the desired 3 percent level. Who knows about the remainder of the year.

The behavior of interest rates has provided more than one conundrum for policymakers in recent years. This may yet be another.

As I've suggested before, there is no shortage of economic, political and geopolitical risk in the world right now. President Donald Trump is supposed to meet with North Korea's Kim Jong Un later this spring. Two interesting published reports suggested the meeting could be derailed.

A mystery train arrived in China this week, and on Wednesday China said Kim had paid a visit, a possible message to the West that Beijing and Pyongyang remain conjoined.

Another report claimed that satellite surveillance shows North Korea re-starting a nuclear enrichment facility, a development that could easily throw heavy water on a Trump/Kim summit.

Oil prices have risen, too, as the geopolitical risk premium in crude has grown amid the jockeying for regional hegemony between Saudi Arabia and Iran.

The president's on-going political problems are well known, but the outcome of his troubles, less so.

The old Wall Street saying that "markets hate uncertainty" is a well-worn, overused expression, principally because it's true.

What's less uncertain to this observer is that the markets are pricing in greater uncertainty and risks that may still be invisible to the naked eye.

Rates will likely tell the tale, but you may have to look in unfamiliar corners of the market to see how the story will ultimately end.