Wall Street's worst week in almost seven years is ending with more turmoil. More than $5 trillion of value has been wiped out in the five-day global stocks meltdown, officially a market correction. Here's what you need to know about financial markets heading into Friday.
Is the 30-year run of falling interest rates coming to an end?
If you came of age in the late 1980s or later, you've never known a time when interest rates weren't falling. Now that era may be ending. Marketwatch shows how the yield on the benchmark 10-year Treasury note — the one that most mortgages and car loans are tied to — has broken out of its long trendline, rising to 2.856% as of 7:30 a.m. Pacific time Friday. Mark Arbeter, president of Arbeter Investments, believes that if the yield breaks its 2013 high of 3.04% it could be headed closer to 5%.
Who else can we blame?
Wall Street is great at creating esoteric instruments that let you bet for or against anything. Some of the worst disasters happen when investors assume they'll be able to unwind those bets all at the same time. The latest villain is an obscure exchange-traded note known as XIV, which let investors bet against stock price volatility. That seemed like a good assumption — prices of the VIX index, which tracks volatility, have been flat for the past year.
Then volatility returned, the index went vertical, and the $1.9 billion investors had sunk into XIV evaporated. "One week, investors were pouring money in at a record pace; the next it was hemorrhaging over 90% of its value," write Bloomberg's Rachel Evans and Carolina Wilson.
Or you can go with CNBC analyst Jim Cramer's explanation, that "a group of complete morons" is to blame for this week's debacle. We think he's referring to those volatility bets. This is 2008-level Cramer frothing.
‘There’s been a 10-year fantasy land that investors have been living in’
Why now? The possibility that the Federal Reserve Board will move next month to raise interest rates and head off a jump in consumer prices is one of the leading explanations for the market correction offered by experts to Bloomberg. Chris Rupkey, chief financial economist at MUFG Union Bank, says the "proverbial punch in the punch bowl is leaving the party," referring, of course, to 1950s-era Fed Chairman William McChesney Martin's explanation of the central bank's inflation-fighting role. For 10 years, the Fed has been artificially repressing volatility, allowing investors to live in "fantasy land," notes Chad Morganlander, a portfolio manager at Washington Crossing Advisors. No more.
No panic so far in ‘haven’ assets. Should we worry?
When stocks head south, the assumption is that investors will pour their money into safer assets, such as Treasuries and the Japanese yen. So far, that's not happening. (It should be noted, though, the dollar is having its best week in four months.) Bloomberg's Mark Cudmore explains that could mean this is going to be a short correction, nothing to worry about. Or not. As we saw in the 2008 financial crisis, when things turn truly horrible, all of Wall Street's tidy assumptions go out the window.