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More Questions Than Answers

Virtually all asset classes were beaten up this week. Stocks and gold garnered most of the headlines, but potentially the most meaningful decline was in bond prices, as interest rates soared for fixed income securities of all types and across all but the shortest maturities. The phenomenon was certainly not restricted to U.S. markets but was observable, rather, throughout the world. Most striking was the upward explosion of Chinese short rates, with their seven-day repo rate rising into double digits.

Rates have been rising aggressively since the end of April, but went into overdrive late Wednesday after Ben Bernanke's question and answer session with the press. Quite predictably, the press and other financial commentators attributed the new high yield levels to the Fed Chairman's reinforcement of previously announced plans to gradually reduce the Fed's massive stimulus program as long as the economy continues to expand. Realistically, he announced nothing new; yet markets reacted violently. With financial commentary now a 24-hour phenomenon, it's highly unlikely that investors simply misinterpreted Bernanke's message. Since Wednesday any number of apologists have emphasized that he broke no new ground. Almost certainly, Bernanke's message had no influence at all, for example, on China's surging short rates.

I expect that we will have a fuller understanding of these volatile market moves in the months ahead. With absolutely no proof in hand and hardly any tangible evidence, I can only suspect that the markets are anticipating defaults of some consequence somewhere around the globe. Leverage has been increasing, dangerously in many areas, as governments have encouraged the expansion of credit to stimulate moribund economies. Beyond recession-bound Europe, rumors have been rife for some time that Chinese banks and regional governments are perilously overleveraged.

There is no current public deathwatch with respect to any specific institution or entity. It would not be surprising, however, to learn soon that one or more new but important cogs in the world economy can't pay its bills.