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Fed Will Open "Pandora's Box" With Rate Hike, UBS Warns

Tyler Durden's picture




 

On common theme we’ve been building on lately as central banks work to monetize all net (and sometimes gross) government bond issuance in their respective jurisdictions, is that QE is destabilizing markets by sapping liquidity which in turn inhibits price discovery and creates volatility. This is on display in Japan, where 2 out of 3 dealers think the JGB market is impaired thanks to BoJ asset purchases and where many officials are beginning to get more vocal about the possibility that a lack of liquidity could have “dire consequences.” Similarly, market financing via shadow banking conduits has declined by nearly half since 2008 in the US, and with dealers unwilling to hold inventory of corporate paper thanks to tougher capital requirements, the stage is set for what the Center for Financial Stability recently called “an accident.” As a reminder, here’s what  the SEC's Daniel Gallagher had to say recently about liquidity in the US corporate bond market (via Bloomberg): 

Lack of liquidity in corporate bond market is “systemic risk” not addressed by regulators, SEC Commissioner Daniel Gallagher says in public remarks.

 

Gallagher cites 80% decline in corporate bond inventories among dealers and impact of higher interest rates on future trading needs; “that has accompanied a record level of issuance year after year since 2008 of $1 trillion-plus of corporate debt”

 

“I would submit to you that the lack of liquidity in our securities markets is a systemic risk,” he says at conference sponsored by Institute of International Finance.

Today, we get yet another warning about the increasing degree of illiquidity in fixed income markets, this time courtesy of UBS, who warns a Fed rate hike could open a “Pandora’s Box” for corporate credit spreads.

Via UBS:

Pandora’s Box: Fed Tightening Is a Problem for Credit 

One of the holy grails of corporate credit is the seemingly innocuous link between Fed rate hikes and credit spreads. Simply put: Higher Fed Funds -> Tighter Spreads. The rationale is intuitive enough. Fed rate hikes are initiated in the context of strong GDP growth and falling unemployment. The hikes are designed to skim some froth from the business cycle, while still allowing the economy to progress through productive investments. This serves to boost corporate profits, open capital markets and lower default risk, all of which support credit spreads. However, we are not convinced this relationship will hold in a post-QE world. Historical parallels and correlations of spreads to shifts in monetary policy expectations can find environments where Fed tightening equates to spread widening. But aside from the direct linkages of rates to spreads, a more fundamental concept is at play. The economic cycle and asset price cycle have diverged, with asset prices looking more like 1999 than either 1994 or 2004...

...the late 1990s and late 1960s demonstrate that a higher Fed Funds can lead to wider spreads in the context of a strong economy, high asset prices, and a lengthened economic cycle. These Fed rate hikes were commenced 98 & 77 months into these respective expansions, which compares to 71 months if the Fed hikes rates in June 2015. Notice as well that the pace of tightening was generally slower than average in these cycles, particularly in 1999. Hence, a fast rate hike cycle is not necessary to increase credit risk when later cycle dynamics are at play. Lastly, in the 1994 cycle, we did see decompression as IG tightened and HY widened. This is perhaps symptomatic of the greater beta of HY spreads to an unexpected shift in monetary policy.

The key takeaway is that recent short-term shifts in monetary policy alter risk premia more than expectations of credit fundamentals, leading to positive correlation spikes. The current divergence between market implied pricing of Fed Funds vs. Federal Reserve forecasts is then a clear risk for credit investors. A Fed that is more aggressive with respect to the pace of tightening will re-price credit spreads wider...

Importantly the evolution of asset prices can diverge from the evolution of consumer prices, as it has before in extreme cases during the US real estate bubble in the mid-2000s or the Japanese real estate bubble during the late 1980s. We believe this divergence has occurred today, with asset prices more characteristic of later cycle dynamics. We present two measures below on US equity prices that illustrate we are closer to 1999 than 1994 & 2004. Margin Debt as a % of GDP is near record levels, and higher financing costs will make that calculus less attractive. The total value of the S&P 500 relative to GDP is also at frothy levels going back to the late 1990s and 1960s. But this is surely not the only metric to investigate. Yield seeking behavior has led to significant market gains in fixed income assets. Indeed, while equity prices look expensive relative to real economic activity, they are arguably cheap relative to bond valuations. S&P 500 earning yields are similar to BB/B bond yields, as opposed to A/BBB yields historically, indicating excessive yield-seeking behaviour in the face of reduced bond market liquidity. 

***

We are left to wonder what happens in the event UBS is correct and a Fed rate hike triggers widening corporate credit spreads in a corporate bond market devoid of liquidity. Could it indeed be the case that the Fed’s highly anticipated “lift-off” will serve as the catalyst for credit market carnage? 

 

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Thu, 03/12/2015 - 08:04 | 5880850 Haus-Targaryen
Haus-Targaryen's picture

Fed cannot raise rates.  The US government cannot afford it. US industry could not deal with the depreciating EUR and YEN vs the USD.  The banks couldn't afford it.  

It will never happen.   

Thu, 03/12/2015 - 08:08 | 5880862 Burt Gummer
Burt Gummer's picture

Jim Rogers says they will never raise interest rates. What is more likely is QE4, actually, it's inevitable. https://www.youtube.com/watch?v=ZCJBqxMlNNg

Thu, 03/12/2015 - 08:09 | 5880865 Haus-Targaryen
Haus-Targaryen's picture

Definitely.  

Deflation then inflation.  

You'll see deflation, something break -- perhaps junk bond market exploding due to oil and nat gas insolvancy.  The Fed will step in -- and then inflation.  

Thu, 03/12/2015 - 08:18 | 5880895 bwh1214
bwh1214's picture

A Fed induced boom can only be maintained through fed support.  The market has essentially flatlined since the begining of the taper, a rate hike will help push it over the edge. 

 

http://www.debtcrash.report/entry/history-and-introduction

Thu, 03/12/2015 - 09:06 | 5880922 So Close
So Close's picture

Systmatic risk is part of a any system.  We  just happen to have a particualry really fucked system in place which is on the verge of collapse.  Crisis will be needed to allow accpetance of the new system.

Thu, 03/12/2015 - 10:57 | 5881490 whotookmyalias
whotookmyalias's picture

These sorts of analysis are bullshit.  The only way it works is if you convince enough people to conduct trades that results in exactly what you predicted.  We have never been in a situation like this, so looking to the 70s and 90s is like betting last week's winning lotto numbers.  It could happen but I'm not betting the farm on it.

Thu, 03/12/2015 - 08:33 | 5880931 new game
new game's picture

liquidity is the word! they will raise rates for ONE reason and only ONE  reason.

the fucking SHOW must go on. a SHOW of CONTROL on the stage of illusion...

Thu, 03/12/2015 - 09:51 | 5881219 iofera
iofera's picture

I give it 60/40 odds that we don't raise rates. If equities tank or there's some other calamity in the next few months, it'll give the Fed an out to save face and hold rates.

Thu, 03/12/2015 - 10:57 | 5881462 whotookmyalias
whotookmyalias's picture

Cause in today's complex world, only the government and certain high profile private institutions can save us from ourselves.

Thu, 03/12/2015 - 08:35 | 5880938 new game
new game's picture

fuck jim rodgers, ask him how his commodity plays are doing?-a fucking puke fuck with a bowtie, ha...

Thu, 03/12/2015 - 10:52 | 5881469 whotookmyalias
whotookmyalias's picture

Yeah, I'm gonna pass on fucking Jim Rodgers. Thanks though.

Thu, 03/12/2015 - 08:04 | 5880851 stant
stant's picture

Stressed out it seems

Thu, 03/12/2015 - 08:05 | 5880854 Shizzmoney
Shizzmoney's picture

The blackmail begins

Thu, 03/12/2015 - 08:06 | 5880857 Tinky
Tinky's picture

Bingo.

Thu, 03/12/2015 - 08:10 | 5880866 Philo Beddoe
Philo Beddoe's picture

We actually have tanks in the streets now. The keys are in the ignition.  If you force us to raise rates...well....vroooooom!!!!!! 

Thu, 03/12/2015 - 08:06 | 5880855 Fidel Sarcastro
Fidel Sarcastro's picture

Pandora's box? Mmmm, I love it when she slips off those panties. 

Thu, 03/12/2015 - 08:06 | 5880856 Fun Facts
Fun Facts's picture

The FED opened pandoras box with QE and they definitely aren't going to close it by raising interest rates.

Thu, 03/12/2015 - 08:16 | 5880879 Philo Beddoe
Philo Beddoe's picture

Reminds of the scene from Raiders of the Lost Ark when the Nazis opened the Ark. I think bankers have learned their lesson from that scene. Just to be safe I am going to keep my eyes closed next Wednesday at 2 eastern. 

Thu, 03/12/2015 - 08:08 | 5880863 firstdivision
firstdivision's picture

Rate hike?!? Hahahahahahahahahahahaha!  I'll believe it when the Fed openly admits that QE failed and was nothing more than to make sure bankers got their million dollar bonuses.

Thu, 03/12/2015 - 08:26 | 5880908 yogibear
yogibear's picture

In some cases billion dollar bonuses.

Thu, 03/12/2015 - 10:53 | 5881477 whotookmyalias
whotookmyalias's picture

In some cases consulting agreements for their family and cronies that billed 6 figures a year for pretty much nothing.

Thu, 03/12/2015 - 08:11 | 5880872 Vincent Vega
Vincent Vega's picture

Pandora's box was opened when the Fed was created.

Thu, 03/12/2015 - 08:45 | 5880979 nmewn
nmewn's picture

True...or any "central bank" that backs a currency derived from the premise that debt can be serviced by a society of hamburger flippers & EBT card holders.

Thus the paradox (and the trap) of debt money and the Looting Class.

"But we have given you tax credits and Farrreeee health insurance!!!" But you destroyed the good paying jobs, so its rather like a mugger allowing you to keep some of your money to catch a cab home isn't it? 

My personal favorite, "Buy stawks & bonds!"

Why, so you can continue to loot within your contrived ponzi scheme based on your status? Which leads to something else, they seem inordinately preoccupied with what someone has in a Swiss bank account or stuffed under a mattress, yet one can trade these stock & bond "currency vehicles" all around the globe, just pay your damned taxes & commissions on that which is derived from...absolutely nothing...and its all quite legal.

Currency today is someones idea of a sick joke, now the only option they have left is to create still more money from nothing in order to service that which cannot be serviced by productivity so the ledger can come to balance?

In other words...counterfeit...an activity they regularly throw people in jail for...lol.

Thu, 03/12/2015 - 09:14 | 5881062 StupidEarthlings
StupidEarthlings's picture

"But you destroyed the good paying jobs, so its rather like a mugger allowing you to keep some of your money to catch a cab home isn't it? "...

 

More like a mugger allowing you to keep some of your money, so he can rob you again tomorrow.. and kick you in the ass..and gang rape you with his pals...and fuck your cab ride home, you can walk/limp bitch.

Thu, 03/12/2015 - 09:27 | 5881107 nmewn
nmewn's picture

lol...yeah, its hard for some to tell the good guys from the bad guys.

But certainly not all of us ;-)

Thu, 03/12/2015 - 08:13 | 5880884 Its_the_economy...
Its_the_economy_stupid's picture
Fed Will Open "Pandora's Box" With Rate Hike, UBS Warns

 

You mean, "Close Pandora's Box". Its been open for 7 years.

Thu, 03/12/2015 - 08:21 | 5880902 mrdenis
mrdenis's picture

Fed to hike rates  0.0000000001%

Thu, 03/12/2015 - 08:26 | 5880906 ThisIsBob
ThisIsBob's picture

Fed used to raise rates to cool the economy down, now they are to raise them to heat the economy up? 

Thu, 03/12/2015 - 08:29 | 5880917 Philo Beddoe
Philo Beddoe's picture

In the new normal you make popsicles in the toaster and boil water in the freezer. 

Thu, 03/12/2015 - 08:28 | 5880913 buzzsaw99
buzzsaw99's picture

if they raise the ffr it will just lead to a new round of qe and bailouts

Thu, 03/12/2015 - 08:28 | 5880914 yogibear
yogibear's picture

"relative to real economic activity, they are arguably cheap"

LOL, more stock buy-backs and full-time to part time jobs?

Only on Wall Street.

Thu, 03/12/2015 - 08:29 | 5880919 winchester
winchester's picture

call  it fedora box

Thu, 03/12/2015 - 09:16 | 5881072 Chauncey Gardener
Chauncey Gardener's picture

Moar like "Fedzilla's" Box...

Thu, 03/12/2015 - 08:30 | 5880921 Niall Of The Ni...
Niall Of The Nine Hostages's picture

Pandora's box would be preferable. Hidden at the bottom was hope.

There's no hope for the American economy for anyone who isn't a bankster. The point of QE was to let them cash out. When the Fed raises rates it's the proles who'll be kicked in the teeth. As usual.

Thu, 03/12/2015 - 08:37 | 5880941 Tasty Sandwich
Tasty Sandwich's picture

Pandora's box has already been opened.

It's a part of being human.

Curiosity killed the cat.  Curiosity created the h-bomb.

Peace is Our Profession.

Thu, 03/12/2015 - 08:40 | 5880953 BadDog
BadDog's picture

I would suggest at least an immediate 3% increase with incremental rises to 5% by next year.  That should fix things.  Cost of capital would be back in line with past periods of economic vitality and the sweet humming of the economic engine would be heard throughout the land.

Thu, 03/12/2015 - 08:51 | 5880993 Peter Pan
Peter Pan's picture

The correction is well and truly needed but the problem is that there will be so much liquidation of unviable activity and malinvestment that it will trigger a domino effect of such magnitude that everything will burn. At that point we can all expect the arrival of the new world disorder.

Thu, 03/12/2015 - 08:39 | 5880955 Last of the Mid...
Last of the Middle Class's picture

The fed is the market, everyone knows this. They can raise rates but somewhere somehow they'll have to manufacture money to cover it. The economy now just won't support it especially after all the dead wood responsible for the depres. . . err i mean recession wasn't removed through natural economic processes.

Thu, 03/12/2015 - 08:48 | 5880984 youngman
youngman's picture

If they raise...how much do you think they will raise....   25 basis points or 100 basis points...I thinkit will be a little if any...I think they will play the word game for a year or two before they do anything....after the election of course...

Thu, 03/12/2015 - 09:19 | 5881083 StupidEarthlings
StupidEarthlings's picture

agreed. it's all talk these days. In fact, they'll just say they raised rates, and really not do it..it doesnt matter. Everythings rigged yet outa control at the same time..the 'market' is so disconnected from the real world jesus who knows how long they keep it up. Just keep printing.

Thu, 03/12/2015 - 08:48 | 5880986 Peter Pan
Peter Pan's picture

Pandora's box smells bad and I suspect that the smell is about to get worse.

 

Thu, 03/12/2015 - 08:52 | 5880996 Last of the Mid...
Last of the Middle Class's picture

Actually, when you get right down to it, the Fed is Pandora's box, smell, discharge and all.

Thu, 03/12/2015 - 09:03 | 5881031 Dazar Nummers
Dazar Nummers's picture

Obfuscation Obfuscation... The owners of the Federal Reserve are thieves and murderers.

Their wealth confiscation mechanism trundles on....

 Pandora and her damn box.

Thu, 03/12/2015 - 09:08 | 5881050 Woodrox
Woodrox's picture

from david morganover at SH" If you look at the value of the Federal Reserve from 1913 to now, in a little over a hundred years, the Federal Reserve itself will admit that 100 cents is now worth about 4 cents. So, you have lost 96% of the value of the U.S. dollar.... That has been a failure, a tremendous failure. That is a collapse in slow motion. Now, what we are really arguing about is what's going to happen to the last 4 cents of the U.S. dollar.... It looks to me that at some point, a tipping point, that you will get an acceleration ... and things will change dramatically."

SO I say hmm....what rate of depreciation does this reflect and how does it compare to real inflatoion and what is the difference magnified back to the level of GDP.....100 dow to 4 in 100 years reflects approx slighlty less than 4% inflation....100/50/25/12/6/3 or every 18 years (72/4=18) what was the real rate of inflation. ... prior to recently, ran at 3% historicaly which implies a doublung (or halving) every 24 years...which would implies that the 100 should have become 12 after 96 years (round to 100)... so the currency is 33% of the value of what it should have been if it reflected the natural rate of delations (4/12)... dollar should index at 12 from 100 years at 3% inflation vs actual index of 4 which reflects 4% inflation......so the theoretical question is what is the extra level of prininting beyond natural rate of inflation that will ZH > converge on zero.....is inflation natural? fact check has inflation been 3% historically? waht was the value of the dollar change from 1813 to 1913..? and what is the level set readjustemnt back to "wealth" or GDP when we go through revaluation events?  say when US bank #1 and #2 failed?  AND from 1912 to 1913 there was not an impact from friday to monday , but we rather a reflection on what that meant 100 years later-100 down to 4. not disputing the 100 to 4... but what does it really mean aside from the media headline impact.


Thu, 03/12/2015 - 10:56 | 5881489 whotookmyalias
whotookmyalias's picture

You forget about wage growth.  And all the government assistance available to those in need.  And the children, sniff.  Oh, and the internet, thank goodness for Al Gore and his invention.  Our lives are so much better with higher wages.  It leads towards equality.

 

Thu, 03/12/2015 - 09:08 | 5881051 Woodrox
Woodrox's picture

from david morganover at SH" If you look at the value of the Federal Reserve from 1913 to now, in a little over a hundred years, the Federal Reserve itself will admit that 100 cents is now worth about 4 cents. So, you have lost 96% of the value of the U.S. dollar.... That has been a failure, a tremendous failure. That is a collapse in slow motion. Now, what we are really arguing about is what's going to happen to the last 4 cents of the U.S. dollar.... It looks to me that at some point, a tipping point, that you will get an acceleration ... and things will change dramatically."

SO I say hmm....what rate of depreciation does this reflect and how does it compare to real inflatoion and what is the difference magnified back to the level of GDP.....100 dow to 4 in 100 years reflects approx slighlty less than 4% inflation....100/50/25/12/6/3 or every 18 years (72/4=18) what was the real rate of inflation. ... prior to recently, ran at 3% historicaly which implies a doublung (or halving) every 24 years...which would implies that the 100 should have become 12 after 96 years (round to 100)... so the currency is 33% of the value of what it should have been if it reflected the natural rate of delations (4/12)... dollar should index at 12 from 100 years at 3% inflation vs actual index of 4 which reflects 4% inflation......so the theoretical question is what is the extra level of prininting beyond natural rate of inflation that will ZH > converge on zero.....is inflation natural? fact check has inflation been 3% historically? waht was the value of the dollar change from 1813 to 1913..? and what is the level set readjustemnt back to "wealth" or GDP when we go through revaluation events?  say when US bank #1 and #2 failed?  AND from 1912 to 1913 there was not an impact from friday to monday , but we rather a reflection on what that meant 100 years later-100 down to 4. not disputing the 100 to 4... but what does it really mean aside from the media headline impact.


Thu, 03/12/2015 - 09:10 | 5881055 Catullus
Catullus's picture

It doesn't matter. The fed funds rate is meaningless. Banks aren't loaning each other money anyway. It's all a show. Demand for UST is still high across the curve. It will be even if the fed raises 50bp

Thu, 03/12/2015 - 09:36 | 5881150 FreeShitter
FreeShitter's picture

Keep stackin and preppin, the rest will come back to reality in due time.

Thu, 03/12/2015 - 13:21 | 5882105 monad
monad's picture

+ target practice and studying the law. 

Thu, 03/12/2015 - 09:47 | 5881204 pupdog1
pupdog1's picture

Translation:

"Our toxic gambling casino derivatives will go KA-BLOOEY, and everyone will see that our mark-to-FUBAR assets mean we were insolvent all along!  Ba-waaaaahhhh."

Thu, 03/12/2015 - 09:58 | 5881249 N57Mike
N57Mike's picture

Pandora's Box and HOPE ..."Pandora was a woman who lived with her husband in a paradise and was given a beautiful box for safekeeping with the caution that she ought not to ever, ever open it. For a time she remembered and kept her promise to not open the box but eventually succumbed to the temptation and decided to have a peek. The lid flew open as soon as she raised it and a swarm of imprisoned evils flew up and out into the world inflicting pain, greed, envy and manner of suffering on all they found.
Pandora and her husband Epimetheus were also the victims of all these ills, knew they were responsible for the suffering and were grieving their part in it while sitting near the box. In the midst of their lamenting, they heard a small voice crying out from the box, "Open, open, and I will heal your wounds! Please let me out!" and while at first they were afraid to open it and possibly release even more troubles, they eventually decided to see who the plaintive voice came from.
They fearfully opened the box and found a small bright-winged beautiful creature. It was well for Pandora that she opened the box a second thim, for the gods, with a sudden impulse of compassion, had concealed among the evil spirits one kindly creature, Hope, whose mission was to heal the wounds inflicted by her fellow prisoners"

Thu, 03/12/2015 - 10:10 | 5881288 gbcirino
Thu, 03/12/2015 - 10:25 | 5881346 mendolover
mendolover's picture

Oh stop wasting your ink.  The Fed isn't raising anything but the ire of people who see where this whole thing is headed.  

Thu, 03/12/2015 - 10:33 | 5881395 bluskyes
bluskyes's picture

The box was opened a long time ago. Now they're trying to get the spirits back in.

Thu, 03/12/2015 - 13:19 | 5882098 monad
monad's picture

They'll find the spirits in bottles. Spirits open boxes...

Thu, 03/12/2015 - 11:16 | 5881539 AynRandFan
AynRandFan's picture

"excessive yield-seeking behavior"  hahahaha 

No, we always see record low yields on bonds, worldwide, when stocks are peaking.

Only question is whether it will end in a bang, or a Japanese style whimper.

Thu, 03/12/2015 - 11:27 | 5881587 walküre
walküre's picture

They will raise from the "emergency" levels in June and realize in October that they need to buy bonds as well.

That it doesn't make sense has never stopped them from NOT trying it before or was never an excuse NOT to do something.

Thu, 03/12/2015 - 12:08 | 5881779 justtotaketheedgeoff
justtotaketheedgeoff's picture

Dear UBS,

Stop whining and grow up! The markets have been forcibly perverted (get your mind out of the gutter - you know what I mean) since 2008. Rates must and will normalize. Reversion to the mean is always a bitch but better it happen a little at a time than all at once in one of those godawful over the weekend markets mostly closed panics. Now sit up straight, say please and thank-you and stop sniveling!

Love,
Mom

Thu, 03/12/2015 - 12:39 | 5881945 dynamictrader
dynamictrader's picture

When a prositute has no business, she makes it attractive amd offers good price, asia is rising and the dollar is dead, before demand falters, lets show them who we are. every dying fish makes one large jump. sell dollar! its going bust soon.

Thu, 03/12/2015 - 13:36 | 5882156 dalitis
dalitis's picture

Been saying it for months now.

Zero chance of the Fed raising rates anytime this decade.

Do NOT follow this link or you will be banned from the site!