What Rising Rates ACTUALLY Mean For Your Investments
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- čas přidán 25. 06. 2024
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00:00 - Intro
01:40 - Rate hikes explained
02:30 - Impact on fixed income
03:16 - Impact on stocks (theory)
05:21 - Stocks that do best/worst
07:10 - What actually happens
09:37 - Gold and crypto
10:30 - The takeaways
12:19 - Sponsor
We all generally understand that interest rates are bad for stocks, but according to historical data, things aren't as straight forward as you'd expect. We dive into the relationship in today's video
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This channel is for education purposes only and does not constitute financial advice - Richard is not responsible for investment actions taken by viewers. Please seek out a registered advisor if you require assistance (while Richard is a registered portfolio manager at WDS Investment Management, he does not provide advice through The Plain Bagel, which is not affiliated with his employer).
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Here just early enough where I think you'll get this.
You're great at what you do, keep it up! You are by far my favorite CZcams personality on finance and I truly appreciate the hard work and hours you put into this channel.
YES just the video I was waiting for. I've been so confused about the effects of inflation and rate hikes. Really appreciate your balanced and clear-headed take.
See my other comment for my take on the subject. The rate hikes alone aren't the issue and its impossible to answer the original question without considering other aspects of the economy.
DJ. Peter Schiff talks about it all the time
If you need a youtube video to explain this to you. Your a moron and stop investing now
Excellent break down. Great job keep it simple too. This may the best break down I’ve seen especially in terms of understanding.
This ended up being a lesson on the difficulty of causal inference with time series data. There are leads and lags, confounding variables and the like making any sort of serious casual inference an intricate and restricted task
Absolutely, never been 1 variable and the very reason why our economy keeps stumbling time from time due to some entity relaying on few variables and that's my friend is confirmation bias!
They were kind of talking about this in the book the psychology of money. Every generation grows up with different economic circumstances. This leads each generation to often have different views about money.
Im now currently in the. Holding money just a buffer. Put rest in stuff that keeps value much better. But that's just generally because banks give nothing. And im really afraid to lose my "value". It's hard to determine "value" but i don't think in fiat currency.
Like for how the current generation has no money and can barley scrape by if at all because the older generations won't let go of their wealth
Richard you are terrific at educating people in plain (bagel) language.
Another great and informative video. Thank you!
One of the best parts about investing in a rising rate environment (or the break down of stocks beforehand), is that it hits P/E’s across the board, even companies that are very high-quality.
Great bond explanation!
Excellent and educational!
You are a blessing man. This channel has helped me immensely
Thanks for info like always this was *chef's kiss*
great video, very interesting
Always enjoy your topics discussed and your presentation style! Best from Germany.
Absolutely brilliant analysis 👏
Hey Plain Bagel you should do a video on stock splits and how they work with big companies like Google,Amazon and Shopify starting to do splits.
Really like ur videos! kudos! :)
Great content as usual, keep it up!
great video! thanks for this lol
Happy Friday
Thanks for taking time for making Timeline Chapters!
Great video
Thank you Bagel man!!! 👏😀
What a great video!
Everything you said is factually correct, but it doesn’t take into account the add-on effect of the Fed reducing the size of its balance sheet at almost the same pace as they expanded it. The Fed has the luxury of printing as much money as it wants to do meet it’s goals but the real economy has no such counter when the Fed decides to reduce money supply. Liquidity WILL dry up and something is gonna break. Also, the Fed itself has admitted that one of their goals is to reduce stock prices (the market is too expensive). If that’s one of their stated goals, why fight them on it? Don’t fight the Fed.
Thank you.
Thanks
Thanks for keeping everything plain, mr. bagel :)
Thanks buddy
The correlation between interest rate and bond prices is much higher than between other asset classes where other market forces play a much bigger role.
Thank you Conan
Hi Richard, I love your videos and I am currently writing my dissertation on how social media can influence financial literacy and investor behavior, and I would really appreciate if you could spare 20-30 mins for an interview for this project. Thanks in advance and keep up the good work, Adorján
What I found super interesting how investors had priced in the initial March fed rate hike well in advance (ARKK Invest, Alibaba, Tencent as examples all dropped by >60% off the highs), and then rebounded strongly as soon ad the first rate hike occured. So in theory, now is a good time to invest even in tech until the Fed finally decides to cut rate again.
Nah fed is going to raise rates. 50. Basis points which will kill the market. Market is done this year.... ending negative for sure.
Yes but all crashes happen when the fed starts to ease again
@@mriphone1000 you sitting in cash for the time being?
@@Dota2funny seems like it!
@@christianng2828 Warren Buffett isn't. Begs the question of what Easton knows that Warren doesn't.
It means DON'T get a floating rate loan.
A fixed rate loan will only be available at a higher rate than a floating rate bond. As bank's won't have to manage ALM
@@abhijeetrawat216 yes, but it reduces your risk of interest rate hike, which happened shortly after that comment was posted
@@samsonsoturian6013 The economy already expects rising fed interest rate, meaning banks price that in, and given the massive recent history of low interest rates, odds are they will drop back down soon enough (due to political pressure probably). Hence, get a floating rate loan (that has a margin that you can afford) 😉
@@Pingo21 rates are only going to come down after some extreme pain
@@austinluepkes5484 Extreme pain for a lot of people yes. But they have been ridiculously low for a long time. Rates cool down the economy, and is (pretty much) the only tool the central bank has to control inflation (meaning demand really). I still believe the inflation is primarily driven by lack of supply. China still driving their no covid policy being a partly bottleneck. In addition companies fighting to build up depleted stock and partly readjusting their LEAN strategies to accommodate supply shocks is also not helping. But when they said transitory I think they were right, just not on the actual length of the crisis.
If the higher rates, in combination with increased inflation, leads to a housing crash as we saw in 2008 the rates will be 0 again before you know it. Or if supply gets back to normal, inflation drops and the rate stays steady (meaning you overpay on a fixed mortgage).
Short term, yes the rates will keep rising. But since everyone believes that the banks already price that in (as was my original point). So a fixed mortgage will actually screw you as the rates stop rising or drop down depending on whatever happens in the economy.
In short: Getting a fixed rate was a great strategy, 6+ months ago 😉
You are awesome :)
Just wanted to thank you for being one of the only channels on CZcams who actually understands the world of finance & what they’re explaining to their audience and isn’t running any game or scam on anyone.
You and Patrick Boyle are really the only two I’ve seen who explain things throughly, simply & truthfully. This site has gotten to the point where it’s basically a minefield of pumpers and course sellers who most of the time aren’t even knowledgeable on what they’re “teaching” trying to strip money from all their viewers.
Thanks for this one. Would be nice to see another video about bond yields and why for some high yields are a good thing, while they are bad for others…
great vid!
I'm in value stocks and selling covered calls. so, don't mind when my holdings stagnant or fall.
As long it's close to debt free with a decent ROA. I'm happy.
Rates didn't fall because of the pandemic. The fed cut rates starting in 2019 because the market couldn't take quantitative tightening. Which still hasn't begun to this day btw
That default payment in 2019: Ripo, nobody talk about... the market is broke
Had to look up GIC. It's essentially a corporate bond.
Liked and commented because the 12:06 timestamp was so slick.
What is your take on I bonds?
I hit like button several times, for the great content and informative video as well as for the high future returns! Love your content as always.
so a 50% chance you ended up not liking the video?
Awesome backdrop. Blue to orange.
So what about other potnential interest rate correlated impacts on returns, such as interest rates minus inflation, size of increases, or checking stock returns relative to 3,6,9 12, etc months prior to rate increases or intended rate increase announcements to take the market pricing in expected rate increased? Is there any data on these or similar.
thanks for sharing your knowledge, not all bonds lose value during high inflation such as I bonds. the higher the inflation thus a better yield.
ok thanks
Proper time preference requires people to to deter the consumption, acquisition, & utilization of land, labor, & capital in the present for them to be properly bidded off freely on the open market. Savings are usually lent out as well. Depositors, who aren't specialized in the efficient allocation of funds, tend to lend their money to other lenders. These lenders (banks) lend to productive ventures. They pay interest to the banks, & the banks pay interest to their lenders (the depositers).
If they're not lent & instead sit under a mattress, then all they've done is freed up land, labor, & capital onto the market & withdrawn monetary units. Since the ones with the most monetary units are demanded ventures, they accumulate more resources (in direct proportion to how demanded they are). Money is divisible. It's value can be split practically infinitely for ever more people increasing in the population, at a sustainable degree. People must compete for those resources & provide value to others. It's value as a currency is represented by the quality & quantity of the goods/services you can buy, & can buy at a later date.
This deflation increases people's purchasing power & encourages savings. It's healthy! Saving is good.
In times of inflation buy quality stocks. Companies that have good cash reserves that can weather the turmoil of an inflationary environment. Stay away from start ups in these times.
As a general principle assets that produce real income streams (ones that tend to keep up with inflation) should probably be discounted by real interest rates while assets that produce nominal income streams should probably be discounted by nominal interest rates. Nominal interest rates can rise while real interest rates stay low. A transition to a monetary regime of higher inflation would tend to hurt long term nominal bonds more than stocks.
What's real and nominal rates ? Thanks
@@jomigregory7253 if you are discounting investments you should probably have learned that already.
@@jomigregory7253 Nominal interest rates are ones that are expressed in a currency (like dollars). Real interest rates are expressed in terms of the purchasing power in that currency. If you agree to lend someone money at 5% that is a nominal interest rate. If inflation is running at 4% at the time, the real interest rate is roughly 1% - the amount that your purchasing power as a lender is increasing per year.
Thanks! right now I am 40% cash and watching yields. not that i am learning much from this turbulence but starting to average into nominal bonds but slowly in case things go more south
Same I kept some stock but all in cash holding now. Cash is king in time of doubt
@@vonb2792 except when inflation is at 8.5%. in other words, sitting in cash is yielding - 8.5%
@@robert435230 yeah Cash doesnt survive inflation in term of pourchase power over long term. Cash is still better than -20% assets in stocks or -8% somes bouds. Cash is liquid at all time, look all the big Investors and thèse IT compagnies they have more cash than anything else.
@@vonb2792 investing in stocks doesn't guarantee a 20% loss over the next 12 months. There's plenty of undervalued stocks out there doing very well or with excellent potential. Most of my portfolio is green YTD. Unless you YOLO everything on meme stocks equities is the place to be.
Good video on the theory and technical aspects of interest rate hikes. However, the rate hike is only part of the story and I would argue that the bigger factors affecting the economy, and as a result the markets, are inflation and the war in Ukraine.
My takes:
1) The most recent US CPI inflation rate was 8.5% far above the Fed's 2% target. Clearly, the Fed is already far behind the curve on this inflationary cycle and one thing you didn't discuss was the velocity of the rate hikes. Sure, if the Fed only increases rates by .25% at a time then the impact on the market will be less pronounced than if they increased rates at .50% or higher. But then, what happens if the Fed continues dragging its feet and inflation keeps rising?
2) The war in Ukraine is adding more inflationary pressure globally on food and energy prices. Central banks might not be able to mitigate inflation with traditional tools which might lead to a recessionary period regardless of what the central banks do. The question might not be whether we enter an economic downturn but whether we have a crash landing or a soft landing.
3) I believe much of the middle class is being squeezed financially as much as they can handle due to insanely high (overvalued?) housing costs and inflation. Let's face it, a large portion of middle class people can no longer afford to buy a house because housing costs over the past twenty years have far outpaced wages. This means that millions of middle class people are one emergency away from a financial catastrophe which could bring down the entire house of cards down similar to 2008. For perspective, there were 2.3 million foreclosures in 2008.
4) Let's not forget that part of the stock market's gains over the last few years, at least in the USA, are due to Trump's efforts to get re-elected. Remember that Trump passed one of the most comprehensive corporate tax breaks in decades and pressured the Fed to lower rates in 2019 because Trump is a "low interest rate guy." We could argue about how much influence these policies had on the market but its undeniable that they contributed to higher market valuations.
5) During the pandemic we saw governments dump trillions of dollars into the economy. The effect was that the (US) market doubled from 2020 to 2021. If that doesn't scream overvaluation then remember that during the pandemic consumer spending and commercial activity dropped dramatically. In fact, in the US we had two consecutive quarters with negative GDP growth. Some industries got decimated and who knows many many thousands of businesses closed their doors permanently. The Fed estimates that 200 thousand small businesses in the US closed permanently due to the pandemic but the real number likely much higher.
In conclusion, I think its very possible that we're sitting on the largest bubble we've experienced since at least 2008. It only takes one segment of the market to pull down the house of cards that the market is currently sitting on. In one scenario, perhaps, we don't have a full blown recession similar to 2008. However, I think its very likely that the (US) market is still very much overvalued and we will enter a recessionary period of some sort within the next 12 months. In pre pandemic 2020 the S&P 500 was at 3,380. Today, almost exactly two years later the S&P500 is at 4,400. This means that the stock market experienced a 33% gain in the middle of a pandemic while commercial activity and consumer spending took a massive nosedive. I would ask how is that possible but we already know the answer. Lastly, let's be honest, if the US goes into a recession we're likely to bring down much of the first world with us due to our global economic influence. We'll see where all this leads but I wouldn't be too optimistic about market performance over the next couple of years.
Schiller's CAPE for S&P500 is around two sigma from the mean of roughly 15, so it's a matter of time before a recession (regression) to mean with all the layoffs and margin calls to follow. Add to that the housing bubble, inflation, lack of haven in bonds, and lingering issues from COVID and war... I can't see any way out of a massive disaster this year or next (though I'd love to be wrong)
@@ryh5169 . Agreed. Cheers!
I hope you also make a follow up video of the theories of how the market behaves when rates fall ❤️
We already know the answer to that. Look what happened after Trump pressured the Fed to lower interest rates because Trump is a "low interest rate guy."
I think it is true that interest rates are just one factor. I sold some stocks that I had gains on and am buying a vehicle. Others are tired of Covid and out spending money on travel. Many weddings were postponed during Covid, and couples tend to do a lot of spending during and after weddings. The employment level is high. If the Fed doesn't slam the brakes too hard, maybe the rise in interest rates will just have a modest effect.
When all these overleveraged borrowers inevitably must roll over their debt & they're faced with higher rates, they're going to have to default. The assets they're dependent upon are artificially inflated in dollar terms. Productive capacity is hindered by artificially low rates. It distorts our time preference, misallocates land, labor, & capital to lesser demanded ventures, & distorts prices signals (because of relative price stickiness, unequal velocity within different sectors, & circular demand within scarce demanded goods [assets]). When rates rise after credit expansion borrowers must default & free up all that land, labor, & capital onto the open market.
THIS IS GOOD!
The crash is the correction to the malinvestments within the system.
I like the fact we can watch an "old" video and still have it be relevant.
Thanks for this excellent video! It's a great example of what makes your channel special.
Personally, I have no idea what's coming. It would be wonderful to have that kind of information, but there's so much going on simultaneously right now in both the business and non-business worlds it's impossible to make any predictions. Imo, anyway. I'm just hanging on and hoping my investments are diversified enough to take advantage of whatever happens next.
I see a lot of people argue that it's better to switch to paying down the mortgage after interest rates his a certain amount because of the guaranteed return would be beating what the market is returning at that point in time - but wouldn't this be a form of timing the market? By pausing investing in the stock market whilst its at a temp low, you would be losing out on capturing the rebound.
I love black Swan. I have read all of Talebs Incerto. I am reading Drunkards Walk. Are there similar books you recommend?
No change to my investing strategy. With multiple decades to go, just ride through the ups & downs, taking advantage of dollar cost averaging. In the long run the market will go up. Don’t chase trends; average investors underperform because of too much movement.
Just Invest and Hold Long Term Over 5 Years most Stocks will go up In Price and you get Profit
Since you asked
I am actually not sure what I would do for my investments because while past performance when interest hike happen seems going just fine the current situation is quite uncertain with wars going on and stagflations as well, and like you mentioned the debt level all over the world is on an all time high. Maybe we will see a crash that is as bad as 2008, maybe Russia and Ukraine will suddenly come to a peace agreement and normalised oil supply and prices, maybe there are other factors that would happen as well. So yea I am not sure since there are so many uncertainties right now, although I am leaning toward drop in stock prices since it seems unlikely situation would stabilised easily.
Stagflation? I think you mean inflation.
If I may, uncertainties is and will always be present. In the last 20 years alone we have had a lot of wars, epidemics, economic crisis, financial bubbles... And - and it is useful to remember this fact - we have had so many more wars, epidemics, economic crisis and financial bubbles that ALMOST happened.
Tomorrow will be no different. If you don't think you can manage all this uncertainties, you can shift your portfolio to safer assets.
I tend to just remember Peter Lynch's quote "There's always something to worry about in the stock market". You can easily lose peace if you stress over every macroeconomic factor, but the truth that any meaningful prediction is beyond most of us. All i would do is just buy companies with stable cash flow and that aren't swamped in debt. It's obviously trickier than just that, but it tends to help avoid disasters long-term.
@@silversoul5285 . Peter Lynch is a hypocrite. Its impossible to arrive at fair intrinsic value of a firm's future cash flows without taking into account the economy at large. Its mathematically impossible. Any investing without accounting for the macro economic environment is just wishful thinking. People who can't understand this shouldn't be giving financial or investment advice.
@@MrSupernova111 I don't think he ever denounced the macro entirely, my interpretation is only that he warned against obsession over it before prioritising understanding of the businesses you buy. Of course nothing exists outside the economy, but maybe one could lose perspective fixating on money supply and trying to make other ambitious predictions?
This will KILL OFF those who wish to buy into the housing market. Housing goes up 200k average a house and now the % goes up too! Who can pay that?!?
If I want to purchase stock in blinkist how would I locate them in the stock market.
Great video richard.
Personallly I would continue to hold the great businesses I own, in the stock market.
If u did due diligance, then fear isnt really intresting now
Why not etf?
@@comedyman112
Theres no prob holding an etf too.
Invest in what you understand
I'm 80% invested in REIT's
and we want ticktok roasts too! thank you!
Been listening to him for years. He speaks the truth about investing.
Could up down or sideways.
Great video as always. I agree with you on the impact on the stock market. A wise man once said “prices lead fundamentals”
I am more concerned about the cocktail of very high valuation levels, skyrocketing energy prices and rising rates.
High interest rates are bring valuations down to Earth as we speak. That means your calls are about to be demolished
@@samsonsoturian6013 and I am very much looking forward to it, since I am mostly in cash
His predictor of future returns strategy has merit ngl
This right here @8:48!! Maybe the central bank has a good track record of seeing when the economy is too hot!! 🔥
It means your calls on hot growth stocks are going to get demolished if they haven't already.
Companies took advantage of low interest rates and cheap money after the GFC to boost the bottom line but now that it’s drying up what will come of stock prices? If bonds are getting slaughtered doesn’t that equate to liquidity drying up?
Remember Fidelity Magellan fund had great returns in the 70's and early 80's.
So all in Tesla?
I think people get cause and effect wrong. When times are good, rates rise to build up reserves for the bad times. When times are bad, rates fall so we can make it through them. So rising rates are a sign that the economy is strong.
I think we just learned
posted on closing bell 5th may 2022
How can you make a blanket statement... it only depends on the companies you have investments ins... My portfoilio is up 125% this year...
This video aged like fine wine in a plastic cup
Ceteris paribis - all else being equal
People are not buying houses because they want to. But need to. Interest rates and prices won't lower demand. If anything it will hit the supply. So value goes even higher.
🤔 so Peter Seilern is wrong.
It should lead towards markets clearing (malinvestment).. but will it? The political component to central banks will lose their nerve and continue to devalue currency.
actually i have an image that clearly state that s&p500 tends to go up between the first 1-9 rate hikes (i researched this a long time ago).. the "crash" of the market tends to happen when rates go down (not always tho)
Rates often go down do to economy needing to be stimulated so generally speaking falling rates are probably during bad times
Are the rate hikes 25 bases points or 50 basis points?
@@xman7695 thats actually a good point, there were mostly 0.25...but there are 0.5 rise here and there, at 1969, and the spx500 when down like 35%, the duration was 1.5 years..around 1979 and 1981 the fund rate was kind of wild, and spx500 was mostly up before they started to cut --from 1994/march to 1994/april was kind flat, but positive, and between 1999/oct to 2000/april was positive (before the big dump) after that i dont see big rate hikes
This all leads me to thinking again that stock market is just a betting place (dare I say Casino) and only real bet we can I feel pretty good about it is that markets will do better than the current position long-term.
Taking inflation 6+ % into account interest % are still in negative territory.
if you're a looooooooong term investor (under 40) then I'd take advantage and invest in solid companies who's value you expect to rise (or dividend yield). The question is when to buy and where the bottom is. But if you're in it for the long haul and expect times further down the line to be better than now, then I'd say go for it. My portfolio rose by over 50% cause I went BUYBUYBUYBUY when covid hit. I was down 20% but threw more money in and made a nice sum
Car loan? Who does that?
I love you
So in times of rising interest rates is it smart to move from the S&P 500 into fixed income investments, or stay in the the S&P 500 at a discount for the long term? Context: 24 yr old investor
If interest rates stay below the rate of real inflation then fixed income assets make no sense because the value of your investment gets eroded by inflation. Also note that the official inflation rate is usually much lower than real inflation as the CPI is manipulated to make inflation seem lower. I have focused on companies with high cashflow, low dept and good value and have avoided aggressive growth stocks as they rely on high levels of borrowing. There are a lot of quality value plays in the mining sector.
@@rudy8409 I appreciate the insights, I’m not too interested in active investing. Would you recommend something like a large cap value index fund?
just keep buying into the s&p
@@Aurelion_Cole peter schiff's 'europacific international value fund' offers great value companies with good cash flows which are likely to perform well in the upcoming economic environment. but obviously do your own research... im just some random dude on the internet. good luck my friend
I dont know I guess I will try to get some money to invest into a dip on what I already know about and hope for the best. Sellin my stuff.
does this mean that inflatioin is gonna stabilize soon? and just not raise anymore?
Keep dreaming. Also, inflation barely mentioned in this video. See my other comment for my take on the subject.
People are talking about peak inflation now. Some of it just being favorable caparisons to previous years month to this years month in upcoming data. Some of the previous big gainers that moved the inflation numbers up like used cars saw some inflation relief in recent data. But food/energy is still a big question mark to watch right now so it's still a bit early to say for sure.
If you could raise interest rates to double digits that would be great
Turns out it DOES mean line goes down
I’m really scared about investment
Great channel man. Don't need flashing lights and rocket emojis to invest. Just keeping it simple.
I disagree. Your analysis is perfect if you take the perspective that fixed income is primarily an investment vehicle. But it breaks down when you consider that fixed income is also (an in truth, primarily) a funding and liquidity vehicle. Debt instruments are primarily used as collateral. The reason stocks tend to perform poorly over a rate hiking cycle is because funding mechanisms dry up and debt markets become illiquid as collateral is hoarded. Collateral is hoarded because the cost of the collateral rises with interest rates. This illiquidity results in margin calls and forced selling, causing instability and crashes in markets, followed by recessions. Stock prices fall in anticipation of these events, and then crash in the event that they come to pass as correlation goes to one due to fire sales. These tend to be short to mid term considerations except in major events like 2000 and 2008. So sentiment and real economy supply/demand factors can drive individual names and sectors to buck the trend. But overall, markets always brace for impact.
Can you elaborate on this part?: " The reason stocks tend to perform poorly over a rate hiking cycle is because funding mechanisms dry up and debt markets become illiquid as collateral is hoarded. "
Super packed comment. I have a few questions: How does fixed income provide liquidity? Debt instruments are used as collateral to what and by whom? And why does the resultant illiquidity necessarily end up in margin calls?
Few big players selling leads to many leveraged smaller ones to be sold out of their positions as a result
@@SeanSurajJeremiah You are asking the right questions. The TLDR is, look up Jeff Snider, Emil Kalinowski, and Hugh Hendry. The long answer is, debt instruments, like treasuries, corporate bonds, mortgage backed securities etc. are used to collateralize short term loans. These loans are taken by institutions like banks and hedge funds to take on leverage. Rising rates make the collateral they are using less valuable. More importantly, it makes the loan more risky for the creditors, so they demand more collateral to roll over the loan. This demand for more collateral is the margin call. If it gets to the point that they can't come up with the collateral, they have to unwind the leveraged investments the loan was funding. The best of the best collateral is short dated treasuries because the market is deepest and most liquid there. Creditors can dump the collateral on the market quickly without affecting the price. That's why the front of the yield curve is so steep. The scramble for short dated treasuries means there are aren't enough to buy and borrowers start defaulting. At that point, the market flips from too many buyers to too many sellers. Now creditors can't cover the loan loss by selling the collateral. Both sides lose. This is what happened in 2008. In the end, AIG's CDS's didn't lose money, but they couldn't get the collateral to post with JPMorgan. So they had to liquidate at fire sale prices and went under. A similar thing is going on in the nickel market at the LME and was threatening to happen in the coal market with BTU. They have the commodities to deliver on the short contract, but not the collateral to keep the contract open. So they are solvent, but illiquid.
@@MrSupernova111 You and Sean Jeremiah asked roughly the same question. So I'm going to copy/paste my answer to his question.
You are asking the right questions. The TLDR is, look up Jeff Snider, Emil Kalinowski, and Hugh Hendry. The long answer is, debt instruments, like treasuries, corporate bonds, mortgage backed securities etc. are used to collateralize short term loans. These loans are taken by institutions like banks and hedge funds to take on leverage. Rising rates make the collateral they are using less valuable. More importantly, it makes the loan more risky for the creditors, so they demand more collateral to roll over the loan. This demand for more collateral is the margin call. If it gets to the point that they can't come up with the collateral, they have to unwind the leveraged investments the loan was funding. The best of the best collateral is short dated treasuries because the market is deepest and most liquid there. Creditors can dump the collateral on the market quickly without affecting the price. That's why the front of the yield curve is so steep. The scramble for short dated treasuries means there are aren't enough to buy and borrowers start defaulting. At that point, the market flips from too many buyers to too many sellers. Now creditors can't cover the loan loss by selling the collateral. Both sides lose. This is what happened in 2008. In the end, AIG's CDS's didn't lose money, but they couldn't get the collateral to post with JPMorgan. So they had to liquidate at fire sale prices and went under. A similar thing is going on in the nickel market at the LME and was threatening to happen in the coal market with BTU. They have the commodities to deliver on the short contract, but not the collateral to keep the contract open. So they are solvent, but illiquid.
The government wont cut expenses