Tags: Stockman | corporate | bonds | Fed

David Stockman: Watch the Fireworks When Corporate Bonds Explode

By    |   Thursday, 03 July 2014 11:46 AM

Corporate bonds are the roadside bombs of Federal Reserve monetary policy, and soon they will spark an explosion down Wall Street, according to David Stockman.

Stockman, former U.S. budget chief in the Reagan White House, has little good to say about the ultra-loose central bank policy of recent years.

"The Fed's sustained, heavy-handed financial repression has generated the greatest ever scramble for yield, and it is now entering its seventh year," he said on his Contra Corner blog. "Consequently, speculators and bond fund managers are all in the same side of the boat."

Editor’s Note:
New Warning - Stocks on Verge of Major Collapse

According to Stockman, the result is an "artificial one-way market" in corporate bonds of every stripe, which are priced so low (ranging from an average 2.97 percent yield for investment grade to 4.87 percent for high-yield junk) there is no margin left over for risk. Therefore, if rates go up, bonds will lose money.

History shows that sooner or later, very low interest rates are bound to go up in every economic cycle, either because the Fed curbs stimulus or because inflation or another shock triggers a sell-off. The $5 trillion U.S. corporate bond market could then be exposed.

"Accordingly, the exits will be jammed like never before when the corporate bond self-off inexorably arrives. The speed and violence of the impending re-pricing is only hinted at by the thundering collapse of securitized mortgages that occurred in the fall of 2008," Stockman predicted.

"Then the financial IEDs [improvised explosive devices] will explode. Then the bubble-blind Fed will be caught flat-footed one more time. The fact is, its modus operandi is guaranteed to create financial deformations and bubbles, yet its doctrine either denies their existence or asserts an inability to prevent them."

Some of the biggest global investors — the "smart money" — have already started to retrench from corporates, Reuters reported, including Loomis Sayles, GAM and Standish.

"The longer the Fed goes on, the more disruptive it would feel like when it ends," said David Horsfall, co-deputy chief investment officer at Standish Mellon Asset Management. "When the Fed raises rates on the short end, that would almost always cause a disruption. It has to, because rates have been so low."

The Wall Street Journal explained that the corporate bond market is more illiquid than it was before the 2008 financial meltdown.

"Regulations designed to make the banking system safer have hit the ability and willingness of banks to trade corporate bonds. If investors were to try to sell en masse, the fallout could be severe," The Journal reported.

Editor’s Note: New Warning - Stocks on Verge of Major Collapse

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Corporate bonds are the roadside bombs of Federal Reserve monetary policy, and soon they will spark an explosion down Wall Street, according to David Stockman.
Stockman, corporate, bonds, Fed
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2014-46-03
Thursday, 03 July 2014 11:46 AM
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