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2022-05-09 07:00 by Karl Denninger
in Monetary , 1582 references Ignore this thread
Yes, Rates Are STILL Going Higher
[Comments enabled]

Don't be the fool.

We've spent the last nearly forty years, as you can see here, in a generally declining-rate environment.

Let me explain what this means for corporate America.

I borrow $1 million at 13% interest.  This costs me $130,000 a year to keep "outstanding."  I produce nothing for the next five years and pay the coupon with the $130,000 each year.  I've now got $350,000 in cash left (the rest I paid in interest) and I'm very bankrupt since I can't pay the million back -- right?

Wrong.

I roll it over.  I don't have to pay the million dollars.  It's five years later and the rate is 9%.  Now it costs me $90,000 to keep it out, not $130,000.  Note that I just bought myself more time, but since the market is "looser" I can borrow a second million.  This costs me $180,000 a year to keep out, but, in five more years.... I refinance it again at 5%.

Now I've only got $450,000 in cash left -- remember, I've produced nothing -- but now my "nut" annually is $100 large.  Can I get another $2 million?  Probably.  With which I sit for another five years or so and do it again, and again, and now I am eventually down to a 2% rate on the money.

I'm not out of money.  I should have been out of money seven years into this game but I got away with it for close to 40 years.  If I produce anything whatsoever with the funds I'm even better off in terms of my credit posture, and I've probably borrowed even more.  Not $4 million, probably $20 million.

My stock price, which was $5/share back then, is now $3,000 split-adjusted -- and it has split several times.

All I have to do is convince Wall Street -- or some venture hack -- that he's got something here and since the market keeps running and the cost of borrowing keeps getting cheaper they finance folks will keep letting me do it!

Here's the problem: None of that was ever paid back.  None of it can be, because I have no assets that are worth anything and I certainly don't have any money in the bank.  If I had assets originally they're 40 years old and likely out of date and worthless.  How much is an old open-hearth style blast furnace worth these days?  Zero.  In fact it probably has negative value because you would have to pay someone to wreck it out and haul it away, likely more than the iron and steel in the unit is worth.

But now those days, my friends, are over.

I pointed this out in Leverage back in 2011.  Oh yes, there was another burst of stupid left.  There shouldn't have been but there was and in 2020 the 10 year Treasury yield was 0.65% (!!)  You would have thought that the roughly 3% rate in and around 2011 would have been the bottom because with actual inflation running around that number you shouldn't be able to borrow for less than the inflation rate because you will pay it back (if you pay it back) with inflated dollars.

You'd have been wrong.

The difference between 3% and 0.65% is nearly a factor of five in terms of interest cost and thus the amount of leverage that can be out at 3% is less than one quarter of that which can be out at 0.65% for an equivalent coupon.

Right now the TNX stands at roughly 3.1% so that entire 4x multiple has disappeared.

The policies of our government have led to this.  The belief that we can spent six trillion dollars on alleged "pandemic relief" without consequence because rates will stay pinned to the floor was stupid.

Worse what we've done to Russia with sanctions has slammed the door on sequestering trade flows in dollars.  Why?  Because if you produce things overseas you'd be out of your mind to price them in dollars rather than your own currency when your nation might be next.  "Oh, that will never happen" sounds quaint, but how certain are you when if you're wrong you're instantly bankrupted?  Why would you take that risk when you can insist on payment in your currency?  Nobody would, nobody is and nobody will going forward.

This in turn means that every dollar spent in deficit by the federal government will instantly be reflected back into inflation.  No exceptions.

Has the Biden Administration -- and Yellen, who I remind you was running The Fed before she was running Biden's Treasury Department -- said anything about cutting that crap out?  To the contrary; they intend to continue it.

Well, good luck with that.

Note above -- a four times multiple on the amount borrowable at a given interest payment has already disappeared.

Now where was the S&P 500?

About 1350.

What is the difference between 1350 and where it is now?

About four times.

Where do you think the S&P 500 should be trading right now assuming the TNX is going to at least stay here?

Oh sure, the markets will go up and down, maybe quite a lot.  But at the core of things is the cost of financing and whether you can allegedly "build a business" that produces nothing in actual profits yet keeps getting financed and allegedly is worth more and more, and thus has a higher and higher stock price, simply because you can roll over the debt at a lower carrying cost per million every time you feel like it.

Can The Fed turn around and change its mind?  Not really, because as I've pointed out without sequestering the funds overseas via trade, which is nobody is willing to do anymore if they have an IQ larger than their shoe size, all deficit spending instantly reflects back into inflation right here in the United States and the only way to stomp on inflation is to withdraw the excess credit from the system since there's nowhere to hide it anymore.

If you think the market run over the last five or ten years has been "reasonable" you're nuts.

If you think it can be sustained with a TNX at 3.1% and flat to rising you're wrong.

And if you think The Fed is going to allow 5, 6, 8 or 10% inflation prints to continue you're wrong there too because while you might escape being bankrupted by that others will not, it eventually drives people out of the workforce as there is no point if you can't make the bills despite working and the lower half of the economic strata, from the bottom up, starves, riots, burns, loots and revolts.

Yeah.

Oh by the way did you see the recent Consumer Credit numberJanuary revolving (credit card) debt was +11.8%, February 16.2% and March was up more than doubled February's rate at 35.3%, all annualized.

The average American has hit the wall, is surviving on wildly-accelerating credit card balances and either the current rampaging inflation is stomped on now or we're going to get a nasty recession and probable civil unrest -- or worse.

The recession has already started -- by the data -- and is inevitable so all we're debating now is the latter and whether the government and Fed do the right thing or not the stock market isn't going to be trading anywhere near where it is today.

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Thegreatunwashed
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smiley

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I will have NO survivor's guilt, except a bit of shame for all my Schadenfreude.
Greenacr
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Northern Ohio
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@ Tickerguy "January revolving (credit card) debt was +11.8%, February 16.2% and March was up more than doubled February's rate at 35.3%, all annualized."

This is what is keeping all the balls in the air for the average consumer. They ae making slow incremental changes to their spending habit and relying on their credit cards to bridge the gap. My sense is that most folks can do this until the mid-summer timeframe and then it blows up.

Talked to a couple folks I know in retail. Basic staple spending is strong but large discretionary purchases like TV's, etc are beginning to decrease.
Rickylc
Posts: 2568
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Is Everywhere
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The market seems to be willing to get these festivities rolling, steady decline in the futes since open last night, not even the typical pre-market pump yet this morning.

1987, is that you?

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We know they are lying, they know they are lying, they know we know they are lying, we know they know we know they are lying, but they are still lying. - Aleksandr Solzhenitsyn
Cmoledor
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Akron Ohio FEMA region 5
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I appreciate your ability to explain these things to the average schmo like me. Guess were in for a rough ride.

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The whole world is one big ****ing scam
Why are you giving a vulgarity warning here? Our genial host is an advocate of both skull****ing and sodomy via rusty chainsaw. Credit to Rollformer
Ocdawg
Posts: 251
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Let's go Brandon, WI
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As is the norm.... EXCELLENT! smiley

My biggest fear is how clueless Karen and BOOBUS AMERICANUS are to what's now already here. Was at a friend's daughter's big 21st birthday party. You'd think other than "burgers are more" and, "Getting tired of gas going up", the whole world was back to normal. Not a care about anything...

****in CLUELESS
smileysmileysmileysmiley

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"I have certain rules I live by... my first rule...
I don't believe anything the government says. The government doesn't lie; it engages in disinformation"
-George Carlin smileysmileysmiley
Invisiblesun
Posts: 509
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Maryland
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It's a long way down to the bottom. A long, long way down. Best bet will be a swift financial collapse that removes trillions of excess dollars from the system and resets prices back ten years.

And if we were smart we would ban anyone with an Ivy league education from holding an appointed position in the federal government. Your graduates shouldn't be allowed to screw up this badly and your universities not accept some responsibility.
Tdurden
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A lot of "investors" are going to become familiar with the term "dividend trap" soon. Sure, the company hasn't had any real organic growth in a decade and the debt dwarfs the market cap, but they're paying you 9% to hold it. And look at all that free cash flow paying that return to the shareholders! Then it comes time to roll over parts of that monstrous debt load at higher rates. Oops. Then the board is forced to cut the dividend, which triggers a wave of forced selling by pension funds. Then someone notices that some of that financing was tied to the stock price. OOPS. But no one could have seen this coming.

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"I'd like to live just long enough to be there when they cut off your head and stick it on a pike as a warning to the next 10 generations that some favors come with too high of a price." -Vir Cotto Babylon 5

Reason: spelling
Merlin
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@Tdurden
Quote:
But no one could have seen this coming.


I LOVE how this (and many other variations) is the answer in SO many areas of life. Of course you couldn't see it coming. I could, but that's because I have my eyes open, and am looking ahead. You ( not you Tdurden ) couldn't because you CHOSE to not look! GRRRRRRR


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Misemeout
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I've tried to explain this leverage to all the people I know trying to jump into the market now lest they be priced out forever by rising interest. They all should have failed Algebra.
Bluto
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Florida
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So if the 10-year goes to 6.5%, we are looking at a 10X decrease in leverage? Wow!

For years, the stock market has been seen as easy money, with no downside risk. Why buy a CD at 1%, or a bond at 2%, when the Nasdaq will return 30% or more? Lots of people, such as retirees or those on fixed income, are way over-weighted in stocks. I am expecting a brutal bear market with a lot of hard lessons learned.

When is the bottom? When everybody wants CDs and nobody wants stocks. We've got a long ways to go in my opinion.

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"Your heart is free. Have the courage to follow it." -- Malcolm Wallace from "Braveheart"
Hyem
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Incept: 2022-03-10

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Folks just taking a poll here to see your opinions, so please post your replies.

Based on Karl's observations [which I agree with] we'll have continued inflation, followed by continued rate increases...

But do you think that will lead to the mother of all deflations?

After all, once zombie corporations that have been rolling debt in the past 40 years cannot kick the can any further they will either have to file for bankruptcy or have mass layoffs to make up for their past sins...we will end up with deflations in financial markets as they collapse to mark to market, newly laid off workers cutting back spending which will impact foreclosures/home prices, etc.

Is this how you're reading the tea leaves too? Any thoughts?
Tickerguy
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A True American Patriot!
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@Bluto - I-bonds (you can only buy $10k of them a year, however) currently return north of 9%, the interest compounds AND is deferred until they're cashed, and if THEY fail to return principal and interest all your "money" is valueless anyway and you may as well start shooting and eating PEOPLE.

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Tickerguy
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@Hyem - Yep.

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Civil Society requires 99%+ consent.
Stop consenting and it is forced to stop. Always.
No violence required.
Greenacr
Posts: 481
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@ Hyem - I read the tea leaves the same way.

Just not sure on how fast this plays out or the duration of the event
Jesjohn94
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Atlanta
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@Tickerguy I get the impression you are expecting the Feds to increase rates to over 3%. I haven't seen you predict a rate they might go to. I don't see how any long dated treasuries will get sold in this environment. I just don't see any endgame where we are now which is what makes me think the Fed will just stick their head in the sand and pretend it isn't happening. For all the big talk by the Fed we only have 1% rates.
Tickerguy
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Go ahead @Jesjohn94 - keep buying then. I think you should go all-in on this dip. Please. Oh, on maximum margin too.

smiley

Quote:
I don't see how any long dated treasuries will get sold in this environment.

Oh really? Go ask the people who did in 1981 how that 30 year coupon worked out for them. They laughed their ass off at people just like you -- for 30 years and lived on said coupon. Literally. It was the trade of a lifetime and I knew it, even as a young whippersnapper, but I had no ****ing money (literally none) and so I couldn't take ANY advantage of it, which sucked big fat ones. Oh well.

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Civil Society requires 99%+ consent.
Stop consenting and it is forced to stop. Always.
No violence required.

Flappingeagle
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I was born in 1960 so I am old enough to remember the last half of the 1970's onward very well. I know a number of people who bought those high-yielding bonds and CD's in the early 1980's. They came out well.

We are in for the Mother of all Train Wrecks. Unfortunately, while we can get somewhat out of the way, we can't get completely clear we are going to have to live through it.

Flap

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Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave the Rat Race to the rats...
Generalee
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S.W. Ga
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It has been years since Mark to fantasy and money markets ability to hold funds rather than pay the demands came to reality. That was when I realized by the sheer lack of intelligence when people just accepted instead of pulling it out and let them have the circus. I have not invested a damn dime in 401k nor do I have any money market exposure. Been patiently waiting for some event to force these folks that make fake fortunes on lies and leverage. I am often given nasty rebuke of my view but I keep saying where the honest worker being rewarded for their labor? Let it ALL burn.
Dingleberry
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Great explanation and very prescient.....rates have exploded in the past year for mortgages.

I ran into an ex-neighbor who sold when rates were in the 2s. She made a ton of money.

Problem is she is renting and cannot get her bid caught as a lot of hot money is still flowing in RE around here, perhaps a lot of it foreign or Blackrock types, all cash.

So she is renting and rents are going "boom"! So now all that money she made is going "poof", and now she has added stress as a bonus.

p.s. Will the fed do QT and start selling MBS and other junk? That to me is about as important as interest rates.

The fed is always willing to buy trash it seems.
Tickerguy
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@Dingleberry - They will let it roll off, not sell it. If they sell it they take a capital loss (a big one too) which then means they can't pay Treasury, which is bad. So they won't. BUT -- when they mature they won't repurchase. No capital loss that way.

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Civil Society requires 99%+ consent.
Stop consenting and it is forced to stop. Always.
No violence required.
Winesorbet
Posts: 377
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@JesJohn I hear ya. The last 12 years have been incredibly frustrating watching them pull a rabbit out of their hat at the last minute and boom, market goes another 50% up. Hell, even a "global pandemic" couldn't stop it, just the opposite in fact. But now, they seem trapped by the inflation monster. It took 12 years but all that credit creation is finally showing up in prices other than houses/bonds/stocks. I have been half kidding on the forum about how they will find a way again. If they do, I'm really scared what the cause might be as it would have to be pretty damn scary.

Karl may be off on his timing but I've learned he's rarely wrong.
Disgusted
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Don't worry the dickhead Ole Jerome said he's manufacturing a "soft landing" the other day. HA ha ha, there isn't enough lipstick in the world to cover this Titanic pig. And just like doing the exact wrong thing on everything else the Pants ****ter made the world not trust holding dollars anymore with all the sanction bull****, so it will all come right back in higher inflation like TG said. I'm sure they'll lie their asses off about the numbers and raise rates, but they'll be behind the curve using the fake numbers. The problem is, they can lie all they want, when people can't survive on what they're making; it'll get ugly. My guess is soon, ammunition will be the highest value investment you could have made.
Synopsis
Posts: 32
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The implications of rising rates and inflation for so many states and municipalities in the US is not fully appreciated. Like many zombie companies and startups, these states and municipalities were at the debt trough even more!! They financed grandiose schools and buildings, roads, BS government pensions and wages and BS programs of all types. The list goes on and on.

Its all coming down. The stock market, government, real estate. All of it.

Its like a black hole now with so much gravity you cant escape.
Stoic
Posts: 95
Incept: 2021-09-12

LC SC
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@Merlin
Quote:
I LOVE how this (and many other variations) is the answer in SO many areas of life. Of course you couldn't see it coming. I could, but that's because I have my eyes open, and am looking ahead. You ( not you Tdurden ) couldn't because you CHOSE to not look! GRRRRRRR


While I agree that ostrich syndrome is a huge problem I also have to admit that a lot of these people do not have the mental acuity to know that they should look nor have the ability to decipher where to look. They were never taught critical thinking skills either at home or at government indoctrination (public schools) centers. Mom and dad sent little Junior off to school while they both went to work so that they could afford the big house in the suburbs and the two Beemers in the driveway and let the leftist, sexual deviant alphabet "teachers" guide their precious kiddos through the most important development period in their lives.

Mom and dad did ask them how school was while they were all staring at their smartphones while sharing family time around the dinner table and once Junior said "it was fine" the subject was dropped and more important topics such as which NBA player was dating which Kardashian was once again the focus of what little discussion there would be for the rest of the evening.

A dumbed down population is much easier to control. Or so it has been said.

Stoic


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