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By Michael Pento of Pento Portfolio Strategies

December 7 (King World News) - “This Is Going To Shock Investors Around The Globe”


The most important question for investors at this time is to determine how high interest rates will rise; if indeed the Fed’s artificial suppression of yields is truly about to end....


Continue reading the Michael Pento piece below...




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To accomplish this we first must consider where yields were last outside of central bank debt monetization, a recession and the Eurozone debt crisis.  Then, we need to factor in the increased risks to inflation and solvency, in order to arrive at an appropriate estimation for the level of interest rates during 2014.


The last time there was; no QE session, no flight to safety in U.S. Treasuries from European debt insolvency, and the economy was not contracting, was in the spring of 2010.  During that time, the U.S. 10-Year Note offered a yield just below 4 percent.  But it is not accurate to then assume that rates will just gradually rise back to where they were before all three conditions were in place.  Below are the major reasons why interest rates are in fact going to soar:


Credit Risks Have Increased


It is crucial to understand why the Fed’s inflationary campaign will not succeed in bailing out the economy.  While it is true that inflation makes easier for an over-indebted economy to pay down debt, it also, because of ultra-low low borrowing costs, tends to truncate the deleveraging process.  And, if those low interest rates stay in place for a protracted period of time, it causes the economy to become even more leveraged than it was prior to the crisis.  This is precisely what the situation is today.


The proof for this can be found in the borrowing habits of corporations, consumers and the government after the credit crisis unfolded.  It is true that immediately after the collapse of the real estate market, consumers and businesses began to pay down debt.  However, the government immediately began piling on new debt in record fashion.  Corporations then started to accumulate more debt in the spring of 2010.  And consumers have now fully reversed course as well and are happily adding to their debt loads.  


Thanks to the nearly-free money offered by the Fed during the past several years, publicly traded U.S. Treasury debt has soared by $4 trillion (46%) since the spring of 2010.  Corporate debt has also increased by $1.6 trillion (8.2%) during that same timeframe.  And, in the third quarter of 2013, consumer debt jumped by $127 billion, to reach a total of $11.28 trillion—the largest quarterly increase since Q1 2008.  Household debt was up across the board with mortgage debt, auto loans, student loans and credit card balances all increasing substantially.  The significant increase in aggregate debt outstanding in the economy equates to a substantial increase in the credit risk of owning U.S. sovereign debt. 


Inflation Risks Rising


The last time the 10-Year Note was trading at 4%, interest rates had been near zero percent for just over one year.  Now, money has been nearly free for a total of five years.  In addition, the size of the Fed’s balance sheet has soared from $2.3 trillion, to just under $4 trillion (an increase of over 70%).  The inflation risks in the economy have vastly increased given the fact that the supply of bank credit (high-powered money) is at an all-time record high, and at the same time the level of borrowing costs are at a record low. 


So How High Will Rates Go?


The bottom line is the interest rates offered on sovereign debt are mostly a function of the credit and inflation risks associated with owning that debt, not the level of growth in the economy, regardless of what Wall Street likes to claim.  Given the above data, it is clear that the 4% yield on the 10-Year Note seen back in early 2010 will be eclipsed.  Since inflation pressures and the solvency risks to the nation have increased by an average of about 50%, it would seem logical to assume the 10-Year Note should trade 50% higher than where it was back in early 2010.  This will put the 10-Year in the 6% range, which will shock Wall Street even though it is still about 100 basis points below the 40-year average.  Of course, this is providing the Fed is actually going to end its artificial manipulation of long-term interest rates next year. 


Don’t be Fooled by the Consensus


The overwhelming consensus on Wall Street is that the economy will slowly improve and the Fed’s taper will cause that benchmark interest rate to rise gradually back towards 3.25% over the course of 2014, from its 2.83% level today.  However, the real risk is that rates do not rise slowly and by a small increment.  Don’t forget, the Fed has been buying 80% of all new Treasury debt, and it is a buyer that is totally indifferent to price.  


A genuine attempt by the Fed to exit QE will cause interest rates to quickly soar back above 4%, and then perhaps as high as 6% in just a few months after the taper is concluded. 


Therefore, it is prudent to assume the new Fed Chairman, Janet Yellen, will abort the tapering process shortly after it begins.  This is because rapidly-rising interest rates would be devastating to real estate, equities and the overleveraged economy in general.  The shock for Wall Street will be that the Fed reverses tapering its asset purchases and begins adding to the total amount of QE next year.  This will mark a significant turning point for the dollar, international equities and commodities, and investors need to prepare for this so their portfolios are not devastated.


IMPORTANT - Due to recent events, KWN will be releasing interviews all day Saturday and Sunday.


Michael Pento: President & Founder of Pento Portfolio Strategies and the author of

“The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market”

To order from Amazon CLICK HERE.


© 2013 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.


The audio interviews with Bill Fleckenstein, Eric Sprott, Grant Williams, Egon von Greyerz, Dr. Paul Craig Roberts, William Kaye, Michael Pento, Andrew Maguire, David Stockman, Art Cashin, John Hathaway and Jim Grant are available now. Other recent KWN interviews include Marc Faber and Felix Zulauf -- to listen CLICK HERE.


Eric King

KingWorldNews.com

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