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Market professionals terrified of trading on rate hike

By
John Aidan Byrne
Published March 7, 2015, 9:42 p.m. ET

Trading fears are rising faster than the Fed can jack up interest rates.

Take Friday’s action in the markets following a higher-than-expected jobs report. Dow stocks sold off 279 points, while yields on the 10-year note soared more than 6 percent.

These moves may be in reaction to Federal Reserve chief Janet Yellen moving sooner than expected in lifting the benchmark federal funds rate from zero this year. It is no comfort to the many investors riding high on cheap money today.

“Anyone who is heavily leveraged will get clocked. And major liquidations will occur that will create temporary pullbacks in the overall market,” according to Christopher Craddock, CEO at commodities trader CC Trading Co. “All markets will be affected momentarily, from lumber to treasurys,” he told The Post.

Craddock also cites another challenge for many trading desks that have seen much turnover in the past seven years.

“Traders that never had to borrow at 5 percent Fed fund rates are going to get a wake-up call. Because even if the Fed moves slowly, the only move in rates from here is up,” he said.

Craddock is not a lone voice crying wolf. Many others have also identified potential collateral damage from a coming rate hike in this unprecedented environment.

“It does create headwinds for bonds,” said David Lefkowitz, CIO of Wealth Management Research at UBS. “When interest rates rise, typically the market value of the principal of the bond goes down. And if we see interest rates rise, we do think you will see the bond market underperform the stock market.”

But even that may not be a sure bet, according to some traders. Borrowing and margin debt have soared on today’s low rates. The New York Stock Exchange reported margin debt of about $445 million in January as investors sopped up easy money — and then pumped up the stock market to record highs.

“It is really quite dangerous,” said Craddock, describing one investor he knows who’s leveraged to the hilt. “He had a million dollars in actual cash, and was trading as if it was one billion.”

The fear factor? Margin calls triggered by rising interest rates could force a wholesale dumping of stocks. “Some people will still get caught on the short end when rates rise,” Craddock said.

And with rising rates, buybacks by publicly traded companies purchasing their own stock, which juices the share price, may potentially slow sharply as their borrowing costs rise.

Craddock fears another Flash Crash as rates rise and stocks are dumped. “If everyone is the same room and somebody yells, ‘Fire,’ everyone is going to go out the same door,” he said.

“Any trader will tell you that as fast as it goes up, it goes down twice as fast.”

The other financial flashpoint is the American consumer. While the Fed touts signs of a US economic recovery as reason for the first rate increase in seven years, rising rates could set back personal consumption — and choke markets.

“The yield curve is flattening out — all across the world,” said Craddock.

“There is no yield anywhere for debt, even if you go out 30 years. That’s dangerous, as people feel they are borrowing with no risk and lenders are lending with very large risk.”

Default risk, in Craddock’s opinion, is at an all-time high. “If we have another credit crunch, most [foreign] economies are stretched too thin and won’t be able to come in and rescue [us] like they did in 2008,” he said.