What to Watch for Before the Debt Bomb Hits

It’s easy to see things happening once they’ve started, but it’s hard to see the fuse burning down until right before detonation.

But there will be fallout from the coming debt bomb explosion.

The first sign that the fuse is lit will be higher interest rates, which will themselves be lit by percolating inflation.

Or worse, an explosion of inflation.

Right now, inflation across the globe is benign.

However, it’s percolating here in the U.S. and elsewhere.

Here’s what to watch for right before the bomb goes off on some part of the $247 trillion global debt pile…

Incoming Inflation
Our CPI came in at +2.9% over the past twelve months at the last reading, which is well above trend for the past ten years. That baseline’s been about +1.7%.

Besides here, there are signs of budding inflation in some emerging markets, like in Brazil, they’re showing readings of 2.86% as of January 2018. And in Europe, there’s budding inflation in Germany and France, to name a few countries. Even China’s seeing some signs of percolation.

Inflation fears will push central banks to cut stimulus and raise rates, especially here in the U.S.

Those rising rates will have a compound effect.

As rates rise, existing debt takes a price hit, handing bond investors capital losses. Several large inflation readings in a row will cause bonds to sell off in anticipation of inflation in the future as investors fear further capital losses.

But that’s only one part of it. As rates rise the cost to roll over maturing debt rises.

Emerging markets are a prime example of how bad things could get.

Triggers
As rates rise, especially rates in the U.S., the dollar will rise too. Investors will want to park money in the U.S. to grab the additional yield they’d get. To do that they have to buy dollars because U.S. investments are paid for in dollars.

The rising dollar is then a triple-whammy for borrowers, specifically emerging markets borrowers, who must pay interest and principal in dollars. They must come up with more dollars even the interest rate on existing debt hasn’t changed. It costs more for debt service because they need to spend more of their money to convert it into dollars to make service.

Then, of course they have to roll over their debt, starting the negative feedback loop repeatedly as rates and the dollar rise.

That’s one major scenario to watch.

Then there’s the political football everywhere – populism, and maybe exiting the EU or threatening to default if international lenders don’t reschedule debt and cut total principal due.

Any global debtor who impacts international finance, and these days that’s most countries, taking any action or even threatening action, could trigger a bond selloff.

Or, it could be China. The Shanghai Composite is already down 20% since January highs. If it crashes that would send investors across the globe into panic mode and create contagion that would hit all asset classes.

Or, maybe a Russian ruble slide triggers a panic over Russia’s debt pile looking like it will face the same dilemma emerging markets face.

Those are the principal triggers or matches that would light the debt bomb fuse.

I’m watching interest rates, especially the U.S> Treasury 10-year and LIBOR. I’m watching the U.S. dollar, emerging markets, Europe, China, Russia, and a few other hot spots.

Next week I’ll tell you specifically how you can trade all of those hot triggers.

Sincerely,

Shah

Source: Wall Street Insights & Indictments