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Credit Market Warnings Escalate: Barclays, Fleckenstein Sound Alarms

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Alert readers pointed us to new sightings of heightened credit market worries from Barclays via the Telegraph and Bill Fleckenstein via Calculated Risk. What distinguishes them from normal patter about the debt markets is the urgency of their alarms (hat tip Dwight and doc)

The irony here is that the Fed, as Tim Duy points out his his last post, is the Fed is completely boxed in. Some see disaster resulting from the Fed’s failure to raise rates (that cohort contends that even a 25 basis point increase later this year would be insufficient). Willem Buiter is a particularly vocal member of this camp. A minority sees the ECB’s decision to increase rates as the culprit, analogous to Germany’s crippling move during the early stages of the Depression (the ECB has the effect of virtually eliminating the possibility of a Fed rate cut, given the impact on the dollar and thus import prices like oil).

Key quote from the related Calculated Risk post: ‘It’s about to blow!”

From the Telegraph:

Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. “This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that’s possible. It has lost all credibility,” said Mr [Tim] Bond.

The grim verdict on Ben Bernanke’s Fed was underscored by the markets yesterday as the dollar fell against the euro following the bank’s dovish policy statement on Wednesday.

Traders said the Fed seemed to be rowing back from rate rises. The effect was to propel oil to $138 a barrel…The Fed’s stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2pc to 5pc over the last year.

Mr Bond said the emerging world is now on the cusp of a serious crisis. “Inflation is out of control in Asia. Vietnam has already blown up. The policy response is to shoot the messenger, like the developed central banks in the late 1960s and 1970s,” he said…..

David Woo, the bank’s currency chief, said the Fed’s policy of benign neglect towards the dollar had been stymied by oil, which is now eating deep into the country’s standard of living. “The world has changed all of a sudden. The market is going to push the Fed into a tightening stance,” he said.

The bank said the full damage from the global banking crisis would take another year to unfold.

Rob McAdie, Barclays’ credit strategist, said: “The core issues have not been addressed. We’re still in a very large deleveraging cycle and we’re seeing losses continue to mount. We think smaller banks will struggle to raise capital. We’re very bearish – in the long-term – on high-yield debt. The default rate will reach 8pc to 9pc next year.”

He said investors had taken their eye off the slow-motion disaster engulfing the US bond insurers or “monolines”. Together these firms guarantee $170bn of structured credit and $1,000bn of US municipal bonds.

The two leaders – MBIA and Ambac – have already been downgraded as the rating agencies belatedly turn stringent. The risk is further downgrades could set off a fresh wave of bank troubles. “The creditworthiness of many US financial institutions will decline in coming months,” he said.

The bank warned that engineering and auto firms we’re likely to face a crunch as steel and oil costs surge. “Their business models will have to be substantially altered if they are going to survive,” said Mr McAdie.

A small chorus of City bankers dissent from the view that inflation is the chief danger in the US and other rich OECD countries. The teams at Société Générale, Dresdner Kleinwort, and Banque AIG all warn that deflation may loom as housing markets crumble under record levels of household debt.

Bernard Connolly, global startegist at Banque AIG, said inflation targeting by central banks had become a “totemism that threatens to crush the world economy”.

He said it would be madness to throw millions out of work by deflating part of the economy to offset a rise in imported fuel and food prices. Real wages are being squeezed by oil, come what may. It may be healthier for society to let it happen gently.

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14 comments

  1. S

    amen…inflation followed by a vicous deflation swoon. Worthwhile reading againt through Bernanke 2002 deflation speech.

  2. Scott

    Well, maybe the Fed can convince the CFTC to implement that “liquidation only” tactic you brought up previously in the oil futures markets here in the US. I think that would torpedo oil prices pretty quickly. With oil futures in contango, speculators pretty much have strong incentive to keep rolling over their contracts, as momentum players pile into this market.

  3. Peripheral Visionary

    I think what disturbs me most is that no one has a solution to the current problems.

  4. Anonymous

    I don’t believe interest rates even matter at this point. 25 points above or below or 100 points or whatever. It won’t make a difference because the conduit – banks and the whole credit sector beyond – is utterly broken.

    The problem is structural. The Fed – or whoever dares assume that power – needs to go in the pit, preferably with a flamethrower, and purge the financial sector of its bloat, that cancer on the economy.

  5. Anonymous

    Inflation is out of control in Asia, boo hoo. They might want to try running an independent monetary policy.

    As for a wage price spiral, what a crock. The power of labor has so diminished since the 1970′s that that is simply impossible. For better or worse.

    Yes there will be commodity inflation. But with consumers in a savage downturn, there will be no room to raise rates. The long run answer to commodity inflation in this environment of weakened labor is not higher rates, but demand destruction.

  6. Anonymous

    Not only is there no practical solution, anything the government says or does makes matters worse.

    The banks will need another (emergency) rate cut soon.

  7. Peter T

    Long bonds have decreasing yields, unemployment soars, wages don’t increase significantly – this is not a scenario for raising interest rates, and the Fed shouldn’t do so. Americans have lived beyond their means for years and consumed too much oil and imported products, and a gentle slide of the dollar by 50% is one way to correct the problem. Every try to “defend” the dollar, like when the Fed defended the dollar-gold exchange ratio in the 1932 with a hike, would be idiotic, because then the unavoidable decrease in living standard would come through unemployment, and that would be worse.

  8. Anonymous

    “Some see disaster resulting from the Fed’s failure to raise rates”

    The problem with grifters (the Bush Administration) is that they make the mark feel as though there is no way out. Of course, the only way out is to take it on the chin and “do the right thing”. They may as well.

    The Fed is the cause of the serial bubbles. The Administration is the cause of the debt bubble. Either way, the US has to punt.

    Let’s do it. Pull the trigger. Raise rates to 6 %. Tomorrow.

  9. Anonymous

    I agree with the anonymous above me. You’re getting pain either way, might as well do the right thing. The only problem with that is there is that little thing called an election in November and some pain now might just transfer to votes.

    “I think that would torpedo oil prices pretty quickly.”

    That bill passed in Congress yesterday by a vote of 402-19. It’s completely stupid and won’t drop the price of a gallon of gas more than 5 cents if that. All the people that speculate the price of oil have to sell at the end. If there’s too much oil, wouldn’t the holders of the oil scramble downwards to sell? I know some farmers that told me stories of that from years past, why isn’t that going on if it’s a bubble?

    And also, since when did speculation become illegal? Isn’t that the entire point of playing the stock market at all, buy a stock and hope it goes up in price?

  10. Anonymous

    The stock market is, by nature, speculation. But the current over-valuation is a bubble.

    Supply economics, as supported by “Grandpa” McCain is, the road to income polarization and poverty for an increasing number of Americans.

    If we like Latin America, we will love what is in store for us with more Republican (and Dodd-Lieberman) representation.

  11. Anonymous

    “The stock market is, by nature, speculation. But the current over-valuation is a bubble.”

    And if it is, so what? All bubbles eventually pop and right themselves!

  12. Anonymous

    Sy Krass said…

    AGAIN! NO MATTER WHO IS IN CHARGE DISASTER WILL STRIKE! The Republicans know nothing, the Democrats know even less about economics. I dare the Democrats to take charge, what will they do? Explode the deficit (if there is any money left to borrow). Neither has the stones to do what’s necessary – cut spending!

  13. Tom Lindmark

    Hi Yves,

    I tried to email this to you but can’t seem to make it work on your system. I’m probably just too wiped out.

    Anyway, I’ve been in Las Vegas for a conference on distressed real estate. Thought I would go to it to maybe find some deals but found out instead that the whole thing seems to be coming down around our heads. Here is the post I put up quickly tonight and I will try and expand on it tomorrow and Sunday-http://blog.metro-real-estate.com/?p=637.

    Things seem to be deteriorating pretty quickly. What’s your take?

  14. leftback

    Yves, I agree with the statement from Barclays about corporates and high yield rates rising.

    Is there for a way for small investors to be Bearish of corporate debt? The best I could find was a Rydex fund called RYIYX – I have been in this since September – the fund holds CDS, and shorts bonds. It has followed the TED spread to some extent since the end of the Fed interventions in March.

    Anyone got a better vehicle?

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