Market volatility may rise with impending Fed hike and increased debt

Markets mostly rose last week but bonds fell as expectations for an interest rate hike from the Federal Reserve increased after a strong employment report in the United States.

The MSCI All-Country World Index rose 2.5 percent last week, its biggest weekly gain since October. In the US, the Standard & Poor’s 500 Index’s rose 3.0 percent. The STOXX Europe 600 Index rose 1.7 percent to the highest level since 2007. The MSCI All-Country Asia Pacific Index rose 0.6 percent.

Also rising last week were oil prices. Brent crude climbed 9.1 percent to cap its biggest two-week rally since March 1998. West Texas Intermediate rose 7.2 percent.

In contrast, bonds fell last week. The yield on the US two-year Treasury note rose 19 basis points to 0.65 percent and the yield on the 10-year note jumped 32 basis points to 1.96 percent. German 10-year bunds also fell last week, with the 10-year yield climbing seven basis points to 0.38 percent.

Helping to push bonds down was a strong US employment report. The Labor Department reported on Friday that nonfarm payrolls increased by 257,000 in January. Average hourly earnings rose 0.5 percent, the most since November 2008.

Following the employment report, futures traders priced in a 27 percent chance that the Federal Reserve will raise interest rates at its monetary policy meeting in June, up from 18 percent on Thursday.

As a rate hike from the Federal Reserve becomes more imminent in coming months, market volatility could increase.

This is especially so since the global economy, according to a report from the McKinsey Global Institute published last week, is now more leveraged than at the time of the global financial crisis seven years ago.

“From 2007 through the second quarter of 2014, global debt grew by $57 trillion, raising the ratio of global debt to GDP by 17 percentage points,” the report said in its executive summary. It concluded that “absent additional steps and new approaches, business leaders should expect that debt will be a drag on GDP growth and continue to create volatility and fragility in financial markets”.

Indeed, another report last week, this time from the Bank for International Settlements, suggested that the dramatic fall in the price of crude oil over the past few months may have been exacerbated by high debt levels in the oil sector.

“One important new element is the substantial increase in debt borne by the oil sector in recent years,” the report said. “The greater debt burden of the oil sector may have influenced the recent dynamics of the oil market by exposing producers to solvency and liquidity risks.”