Low interest rates and changes in the workings of global bond markets create a toxic combination that could produce "scary" trading conditions for investors, according to Barclays (BCS) - Get Report CEO Jes Staley.
Staley, speaking at a board meeting of the $129 billion pension fund Teacher Retirement System of Texas in Austin, offered one example of how distorted markets have already become: Many investors are now regularly betting on bonds to rise in price while stock investors hunt for yield in the form of dividends from regulated companies like utilities. Historically, most investors sought out bonds for their stability and yield, in the form of coupon payments, and bought stocks for price gains.
"It has completely flipped the calculation of values in the debt and equity markets," Staley said "It's all fine and good right now, but at some point, this is going to unwind, and when it unwinds, what it means to Texas Teachers and Barclays, I think it's scary. You're going to have one hell of a navigation."
Staley joins an increasing chorus of top financial executives, including the hedge fund managers Ray Dalio of Bridgewater and Paul Singer of Elliott Management, who have expressed concern about the potential for heightened volatility as central banks in the U.S., Japan and Europe grapple with historically low or even negative interest rates. There's little room for monetary policymakers to cut rates further to stimulate the economy in the event of a downturn, and higher rates could lead to steep losses for bond and stock investors alike.
JPMorgan Chase (JPM) - Get Report CEO Jamie Dimon said this month that the U.S. Federal Reserve needs to raise rates to avoid losing credibility. Eric Rosengren, president of the Federal Reserve Bank of Boston, said today that further delays could increase the risk of "imbalances" in financial markets.
"Gently backing the economy away from such imbalances has proven to be very difficult in the past," Rosengren said in a statement.
Staley, who previously worked at JPMorgan as one of Dimon's top lieutenants, said he spoke to the Texas pension fund at the request of its chief investment officer, Thomas Britton "Britt" Harris IV, himself a former CEO of Dalio's Bridgewater. Staley also described the Italian and Spanish banking systems, and a significant part of the German banking system, as being "underwater."
"You basically scared the living daylights out of me," David Kelly, the Texas pension fund's chairman, told Staley in response.
The U.S. Fed and Bank of England both have set benchmark rates at 0.25% to 0.5% and the Bank of Japan is at negative 0.1%. Staley noted that U.K. 10-year bond yields are at their lowest in more than 300 years.
"Either you believe that we have a stagnant global economy as far as the eye can see, and all of the populist implications that that has, or you believe that we will be able to generate some level of economic growth, and then you'll have to reverse this monetary policy," Staley said. "What it will do to asset valuations around the world and the level of volatility that it could bring are monumental challenges for the banking industry and for the pension industry."
Speculation over when the Fed will next raise rates -- most investors are betting on December -- comes as many banks have curbed their risk-taking in global bond markets, Staley said. Partly due to stiffer regulations that have made it more expensive for banks to keep large bond holdings on their balance sheets, much of the U.S. Treasury-bond market has migrated into the hands of high-speed computer-driven traders who hold very little capital, he said.
That's problematic because many big investors, including mutual funds, insurance companies, sovereign wealth funds and pension funds, still expect banks to serve as the key middlemen in bond markets.
"To the extent that bank balance sheets are no longer using capital to inventory securities, we do run the risk of a crack in the capital markets," Staley said. "All of this is going to be put under stress once the central bank policies begin to reverse from Japan to Europe to the U.S."
In a brief interview after the meeting, Staley said he didn't know how stock or bond prices would react if market conditions deteriorate.
"We may be nearing the limits of accommodative monetary policy," he said. "It will increase volatility quite significantly, but it's hard to say on direction."
See TheStreet's full coverage of Federal Reserve interest-rate policy here.