Possibly the best quote of the financial crisis era came from Citigroup’s Chuck Prince, in 2007.
You probably know the one I’m talking about. Talking to the FT, he said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”
Shortly afterwards of course, the needle came skidding off the record and everybody stopped dancing. And Chuck – despite demonstrating as good an understanding as anyone of what truly drives financial markets – found he wasn’t Citigroup boss for much longer.
Why am I bringing this up now? Well, the music hasn’t stopped yet at the cheap money disco. But everyone’s well aware that the barman could call ‘last orders’ any minute.
And that’s left some asset classes looking particularly vulnerable…
Companies are rushing to raise cash as the cheap money era fades
The big story last week was the deal between Vodafone and Verizon. It’s a fascinating story in lots of ways. It says a lot about the ongoing reshaping of the technology market, and how we’ll all be paying for and consuming our media in the future. We’ll be looking at all this in more detail in a future issue of MoneyWeek magazine.
But I have to say, what really grabbed me, was the idea that lurking behind this deal was the spectre of Ben Bernanke. When the Federal Reserve starts tightening up, money will no longer be ‘on sale’.
That’s why Verizon wants to raise money to pay for the deal now. It’s looking at selling $20bn in US-dollar denominated bonds alone – some potentially with 100-year maturities. That’d be the biggest US offering in history, says the FT. And it’ll be doing further issues in euros and pounds too.
This is one of the many painful ironies of finance. If it looks like an incredibly good time to borrow money, that usually means it’s a very bad time to be lending money.
It already looks as though the deals that marked the top of the bond bull market have been and gone. Both Apple and arch-rival Microsoft managed to borrow money at unheard-of low rates back in April. Anyone who bought into those issues is feeling a little poorer now, as yields have risen and prices have fallen.
The desperation isn’t just restricted to the Verizon deal. Europe’s corporate bond market raised nearly $29bn in the last fortnight alone, according to Dealogic. And already this year, according to the Dealbook blog, more than $650bn of investment grade corporate debt has been issued. That’s close to the record levels seen in 2007.
As Denis Coleman of Goldman Sachs tells the FT: “People are suddenly thinking: let’s get in before rates get worse.”
But this rush isn’t just happening in the bond market.
The London property market looks particularly frothy, to put it lightly. Property website Zoopla is apparently looking at a stock market listing that could value the company at £1.3bn, or a whopping 50 times earnings.
Now, Zoopla is the second biggest operator of UK property websites by page views, says the FT (after Rightmove). It charges estate agents to advertise on its website. But that’s still an incredible valuation by any standards. Particularly as Rightmove is still by far the most dominant player.
I’m having difficulty seeing how that valuation can be justified, except that people are so desperate for exposure to the UK property market that they’ll pay any price to get in. Meanwhile, Foxtons – the famously aggressive London estate agency – is looking to return to the market too. And even furniture chain DFS (another property-related play) is thought to be sounding out advisors.
There’s an obvious link between these two markets. Both London property and corporate bond markets are very vulnerable to rising interest rates.
When will rates rise?
So the question is: when?
While the Federal Reserve might start to ‘taper’ as soon as this month, that doesn’t mean interest rates will rise. There’s a while to go before the Fed pulls that lever.
The way I see it, this is all about politics. Central banks are independent in name only. Ultimately they are answerable to the government. So rates will rise only when it’s the least-bad option politically.
People idolise Paul Volcker – head of the Fed in the early 1980s – as a tough Fed chairman. He certainly strikes me as a smart guy with a lot of integrity. However, it’s also worth remembering that the political calculus was very different when Volcker was in charge. Voters didn’t like rising interest rates. But they didn’t like painfully high inflation either.
For now, it’s still politically problematic for central bankers in the developed world to raise interest rates. Particularly in Britain, where an election is looming.
But there’s only so long that this can continue. If the UK economy continues to rally, then Bank of England governor Mark Carney is going to look increasingly wrong-headed. And unlike in the US, inflation is already on the cusp of being a problem in the UK. It really doesn’t have to go a lot higher to start creeping into the headlines.
In terms of what this means for your money – as my colleague Merryn Somerset Webb has pointed out, equities don’t tend to start panicking about inflation and rising interest rates until we hit the 4-5% mark. But I’d be very careful about the extent of the bond exposure in your portfolio. And if you’ve been considering fixing your mortgage rate, I think you can probably do so safely here without worrying too much about regretting it in the future.
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