While all eyes are on interest rates in the Treasury market, an even more important global interest rate recently breached a key level for the first time since the financial crisis: the London Interbank Offered Rate (LIBOR). On December 29, 2016 LIBOR hit 1% for the first time in seven-and-a-half years.
I wrote back in October of last year, when LIBOR had reached 80 basis points, that a move up past 1% could spell trouble for the credit markets. We have now reached that point and are starting to see signs of strain on which we need to keep a close eye.
LIBOR is an uncannily accurate thermometer that measures the banking industry’s health: in normal times, low rates mean banks are doing well, while higher rates indicate reduced public confidence and a struggling industry. Right now, we are not living in normal times and it is more difficult than in the past to determine how to read market signals such as LIBOR. Nonetheless, LIBOR remains an incredibly important global benchmark and its rise will meaningfully increase borrowing costs across the global economy.
Corporate credit quality is deteriorating not only among junk borrowers but among investment grade companies that borrowed tens of billions of dollars to pay dividends and buy back overvalued shares. 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. And that is what they are facing if rates rise even modestly.
Here’s what to expect now that LIBOR has breached the 1% mark – and how you can profit.
The world awoke to a new political and economic regime on January 20 as Donald J. Trump took the reins of power from Barack Obama and announced a populist, America-first agenda. Mr. Trump enters the White House with a 37% approval rating while Mr. Obama never saw lower than a 38% approval rating (and entered with a 70% rating). Perhaps this is why investors are taking a measured view of their new president after pushing stocks sharply higher in the weeks following the election. The US stock market plateaued last week, with the Dow Jones Industrial Average falling 58.48 points or 0.3% to close short of the 20,000 mark at 19,827.25. The S&P 500 dropped 0.1% to 2,271.31 and the Nasdaq Composite Index lost 0.2% to end the week at 5,555.33. Ten year Treasury yields rose slightly to 2.47%. The initial repricing of financial assets triggered by Mr. Trump’s election may be over.
The most significant market move occurred in the US dollar last week, which dropped sharply after then President-elect Trump told The Wall Street Journal that the dollar is “too strong.” After these comments, the US Dollar Index (DXY) fell sharply to 100.81, giving up a significant portion of its post-election gains.
This first assault on the dollar might be just the beginning.
In the coming months, President Trump could very well reverse the dollar’s rally completely – and he may do it on purpose.
If that happens, here’s what to do.