Investors need to keep an eye on a key interest rate that helps to determine borrowing costs among the world’s biggest banks, says Michael Lewitt, investment strategist at Third Friday Management Llc.
A rise in the London interbank offered rate, or Libor for short, may signal that fixed-income securities are in danger of losing value, he says in the October issue of his Credit Strategist newsletter. Bond prices move in the opposite direction of yields.
“Credit markets are in an epic bubble that threatens to inflict major pain on investors,” Lewitt says. “Risk/reward in the credit markets is as poor as I’ve ever seen it in three decades.”
Libor last month jumped to a six-year high even as the Federal Reserve kept interest rates unchanged near record lows. U.S. three-month Libor is now at about 0.8 percent, more than double the 0.3 percent average since 2009, possibly indicating higher risks in the capital markets.
“Libor remains an incredibly important global benchmark and its rise will meaningfully increase borrowing costs across the global economy,” Lewitt says. “This move goes largely unnoticed by investors while they freak out at the mere whisper of a possible 25-basis-point hike in the Federal funds rate.” A basis point is one-hundredth of a percentage point.
The Fed this month kept its key interest rate near 0.4 percent, in line with market forecasts for no change in the cost of borrowing within two months of the U.S. presidential election on November 8. A 0.25 percentage point rate increase last December was partly blamed for a stock-market decline of more than 10 percent during the first two months of this year.
“While the inability to earn a decent return on capital in fixed income markets poses enormous challenges for investors, outright losses are far more dangerous,” Lewitt says. “And that is what they are facing if rates rise even modestly.”
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