Bond Markets Could Be In For A Shock
As I have stated previously that while the Federal Reserve sets short term interest rates, it is the market that determines long term rates and that market could be in for a big shock. Reports have surfaced recently of a threatened massive selloff of U.S. Treasury Notes by China in response to proposed trade sanctions.
With China holding an estimated $1.3 Trillion of our national debt, this would wreak havoc in the market and send bond prices tumbling and long term yields soaring. An already weak housing market would face further upheaval and damage to the rest of the economy would be incalculable. Any new bonds issued would have to match these higher yields.
The Dollar which has lost over 30% of its value over the last few years would depreciate even further. With higher long term interest rates, economic growth could be severely impacted and coupled with rising energy and commodity prices we could be in store for a period of stagflation.  This is a term used to describe a situation where an economy faces a recession coupled with high inflation, basically the 70’s all over again.
The financial sector couldn’t get much worse news than this, having already posted huge losses this quarter and which many analysts predict will only get worse, as the sub prime mortgage catastrophe goes through its final death throes next year. Not only will institutional investors be affected but many individuals as well, everyone who has a pension funds or that holds bonds as part of a basic diversification strategy.
Years of fiscal irresponsibility by the government has led us to this day and you can blame both political parties as neither has done anything, while they were in control, to stem our ballooning national debt. And rest assured if China does follow through with its threat, we will respond in some way and we could see an economic war, the likes of which the world has never seen.
