Higher Interest Rates “Pound” Financial Markets | News or Noise

Nine Months and Counting:

2022 has been a bad nine months for investors in stocks and bonds globally. Stocks have now almost roundtripped two years of gains, which while common, is not enjoyable. What’s the culprit? Treasury bond interest rates increasing at the fastest pace in decades.

• Take a look at the Change in Fed Funds Rate chart on how fast the Fed is raising rates vs prior cycles. Over the last 40 years, only Greenspan in 1994 comes close.

Across the Pond:

I’m Chris Perras, Chief Investment Officer with Oak Harvest Financial Group. And This is our investment team’s mid-week release when we examine a news item, headline, or story making the rounds from publicly available sources and ask, “Is it News or Noise?” for your money. This week we discuss the Bank of England’s emergency intervention in bond markets on Sept 28th.

Last week, the Bank of England launched a historic intervention to stabilize the U.K. economy, announcing a two-week purchase program for bonds and delaying its planned currency sales until the end of October.

The move came after a massive sell-off in their government bonds which was crushing public pensioners’ defined benefit retirement plans. In the U.K., defined benefit pension plans that provide a guaranteed annual income for life upon retirement based on a worker’s final or average salary are still popular. Most private US companies have gotten rid of these over the last 40 years in favor of defined contribution plans like 401ks and IRAs.

Most public school systems in the U.S. have these defined benefit plans, but ERISA rules do not allow them to take on leverage and margin in investing. Some of the bonds held by these pension funds had lost around half their value in a matter of days with the rapid rise in interest rates and a decline in their currency, the pound.

The plunge was so fast and sharp that many U.K. pension funds began receiving margin calls. Margin calls? Are pension funds getting margin calls? Remember, a margin call is when your broker calls and demands you increase equity in an account that has fallen below the broker’s required amount. So I ask it again, Are pension funds getting margin calls? Yes, many pension funds in the U.K. own something called an LDI.

This is short for a liability-driven investment fund. These LDIs are owned by defined benefit pension plans, which risked falling into insolvency as the LDIs, which are leveraged instruments, were forced to sell bonds, in turn driving down prices and sending the value of their assets below liabilities. In its emergency purchase of bonds, the Bank of England is setting out to support prices.

Think of our Fed restarting Q.E. or quantitative easing here in the states. The U.K. central bank did this to allow funds time to manage the sale of these assets. What does this mean to investors in U.S. stocks and markets?

It means that the Federal reserve interest rate increase path has been so fast that it’s stressing and breaking esoteric parts of the financial markets. Much as Alan Greenspan’s doubling of interest rates caused the Mexican currency crisis in late 1994, Chairman Powell’s race higher is causing stress in other countries and other assets beyond our shores. It means that it’s likely, a lot of the short-term volatility and selling at the end of last week in our stock markets was coming from overseas and being done in a forced manner.

The Synopsis:

This is news to your investments short term. The bad news about this story is other investors’ margin selling can create even more short-term volatility.

The slightly good news and I do mean slight? No one gets a margin call at or near the top in markets. The Mexican peso currency crisis in 1994, also known as the Tequila Crisis, was within weeks of the peak in Federal reserve hawkish rhetoric in 1994 and the stock markets bottom for the next 18 months. No guarantees that’s the case again now, but history does tend to rhyme a lot.

Are you trying to meet your needs or your greed in retirement? Give us a call and schedule an initial consultation with an Oak Harvest Advisor. We will sit down with you and help you and your family do the math to determine if you can meet your retirement goals and needs.

At Oak harvest, we think our clients are best served by us helping them plan for their future needs, instead of focusing on the past. The future is always uncertain and that’s why our advisors and retirement planning teams, plan for your retirement needs first, and your greed second.

Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals.

Call us here at (877) 896-0040, and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years. I’m Chris Perras and from everyone here at Oak Harvest Have a blessed week.