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Watch out for whale-size risks - btbirkett@gmail.com - Gmail June’s jobs report keeps the Federal Reserve on track to raise interest rates this month. You’ll need to make an appointment at an Apple store if you want to buy its Vision Pro headset. Want a full-time remote job? There are coaches charging $3,000 to help. The volatility in the safest markets in the world has been stunning. Over the past two weeks, two-year Treasury yields surged more than 25 basis points into late Thursday, going above 5% for the first time since 2007. The 10-year rate jumped to above 4%. Although there was a paring of short-term yields on Friday in reaction to the jobs report, the overall direction is pretty clear: Interest rates are going higher. There’s even more to this story. The inversion of the yield curve—which has persisted for more than a year and is typically a recession signal—hit its most extreme position since the early 1980s. “It’s a dangerous situation,” says Barry Knapp, founder of Ironsides Macroeconomics. He says that there’s likely to be a “nonlinear credit contraction” and that the Federal Reserve has to be careful because “this deep inversion of the curve is a big problem for the banking system, and there’s no easy way out of it.” A surge in interest rates around the world has led to blowups like a pension fund crisis in the UK, which was forced to sell bonds en masse, and a spate of banks failing in the US. Everywhere you look, there are serious risks tied to the safest bonds in the world. “You throw dynamite into the ocean and see what starts floating to the surface and eventually a whale comes up,” Knapp says. As stunning as the move in short-term rates is the adjustment of longer-duration bonds. In a July 4 note from a team led by Apollo’s Torsten Slok (yes, they still publish on holidays), he writes: “The Fed has started to increase its estimate of the long-run Fed funds rate. … The implication is that the Fed is beginning to see the costs of capital as permanently higher.” Permanently higher?! There’s a whole generation that has grown used to money being free. With a market still wrapping its head around the effects of higher interest rates, it’s worth considering just some of the ripples that are being felt right now. Fed Chair Jerome Powell. Photographer: Nathan Howard/Bloomberg Bank stresses. After this spring’s bank failures, the Fed set up a funding program that had more than $100 billion lent out as of the week ended July 5. That means banks are still being meaningfully propped up by extraordinary borrowing, while facing a trickle of deposit flight. Risky lending. With banks seeking a different business model, driving up their own cost of borrowing, they may stretch to make riskier loans to drum up greater profits. There’s a danger that regional banks could just become zombies, as my Bloomberg colleagues write for The Brink newsletter. Money-market movements. With rates rising, money is still flowing to more lucrative money-market funds. Deposits are bleeding from the system by the tens of billions. Bankruptcies. It’s getting more expensive for companies to finance themselves, so you’re seeing Chapter 11 filings tick up at the fastest rate since the financial crisis. They’re nowhere near where they were in 2008, but it’s an open question whether they’ll keep ticking up if rates stay high and a recession hits more companies. High-yield questions. For all the selloffs in safe, government bonds, global high-yield debt has been one of the better performers this year. Why aren’t recession concerns keeping people away from risky debt? One reason is how closely it tracks to equities. Leveraged loans have done even better this year, mostly because they have a floating rate. Both, however, are vulnerable in a downturn—meaning investors could lose a lot of money if things go south. Consumer stresses. Higher interest rates mean higher mortgage rates, which have hit their highest levels since November. Student loan repayment is set to begin soon, adding $200 to $300 to an average American’s tab each month. Apollo’s Slok also points out that credit card delinquency rates are at 2008 levels and auto loan delinquencies are rising. Spending on items that require financing such as furniture and electronics is also slowing, he notes. “That is the old adage: The Fed hikes until something breaks,” says Jim Bianco of Bianco Research. He says he’s watching liquidity closely, including the rate at which Treasuries are issued and purchased, as well as the Fed’s quantitative tightening program. “Maybe there's something more to break here, we’ll see. But the direction of rates is still higher, and the market isn't fully embracing this idea.” All of this is a good reminder that we all as humans, corporations and governments are vulnerable to the surge in the cost of debt, especially after an entire era in which debt was essentially free. Knapp calls it a “nonlinear credit contraction,” but big hedge funds have a different name. A “slow-motion car crash” is how Brian Higgins of King Street Capital put it, according to a Bloomberg story discussing his plans to raise money. His firm and others, like Angelo Gordon and Brookfield Asset Management, are building war chests, readying for shake-ups in credit markets. They expect that crashes may not be swift and abrupt, but instead may be like hiccups in fits and starts, as they have been for the past year. “The last chapter of this story will be written when the Fed eventually starts cutting rates, but that's not happening soon,” Bianco says. —Sonali Basak, Bloomberg Television’s global finance correspondent