Markets Break When Interest Rates Rise Fast: Here Are the Cracks
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Markets Break When Interest Rates Rise Fast: Here Are the Cracks

Turmoil in Britain exposes potential risks facing pensions and government bond markets, longtime havens in periods of financial upheaval

By JON HILSENRATH
Thu, Oct 6, 2022 9:09amGrey Clock 7 min

Central banks are raising interest rates at the fastest pace in more than 40 years—and signs of stress are showing.

Recent turmoil in British bond and currency markets is one. That disturbance has exposed potential risks lurking in pensions and government bond markets, which were relative oases of calm in past financial flare-ups.

The US Federal Reserve and other central banks are raising interest rates to beat back inflation by slowing economic growth. The risk, in addition to losses in wealth and household savings, is that increases can cause disruptions in lending, which swelled when rates were low.

Major US stock markets recorded their worst first nine months of a calendar year since 2002, before rallying this week. Treasury bonds, one of the world’s most widely held securities, have become harder to trade.

There also are signs of strain in markets for corporate debt and concerns about emerging-market debt and energy products.

Most analysts still don’t expect a repeat of the 2007-09 global financial crisis, citing reforms that have made the largest banks more resilient, new central bank tools and fewer indebted U.S. households.

“So far there haven’t been any really bad surprises,” said William Dudley, former president of the Federal Reserve Bank of New York.

Some pain is expected in the fight against inflation. Raising interest rates usually leads to lower stock prices, higher bond yields and a stronger dollar.

Yet abrupt adjustments can lead to a slowdown more severe than what the Fed and other central banks want. Threats to financial stability sometimes spread from unexpected sources.

“There are no immaculate tightening cycles,” said Mark Spindel, chief investment officer of MBB Capital Partners LLC in Washington. “Stuff breaks.”

The current tightening follows years of short-term rates near zero and sometimes below. Historically, low rates encourage risk-taking, complacency, and leverage—the use of borrowed money to amplify profits and losses. In recent years, central banks also purchased trillions of dollars of government debt to hold down long-term rates.

Low central bank rates were one reason that yields on corporate debt fell to less than 2% from about 6% between 2007 and 2021. During the same period, corporate debt ballooned to about half the size of the U.S. economy from 40% a decade ago. Yields shot higher this year, triggering unexpected losses.

In one case, investment banks including Bank of America Corp., Credit Suisse Group AG and Goldman Sachs Group Inc. are on track to collectively lose more than $500 million on debt backing the leveraged buyout of Citrix Systems Inc. after it was sold to investors at a steep discount. Shares of Credit Suisse, which is restructuring to exit risky businesses, fell 18% over the past month while the cost of insuring its debt against default, as measured by credit-default swaps, soared.

Meanwhile, the dollar has risen steeply against other currencies, threatening higher interest costs to emerging-market governments that borrowed heavily in recent years from foreign investors seeking higher returns. The foreign debt of low- and middle-income countries rose 6.9% last year to a record $9.3 trillion, according to World Bank estimates.

Emerging-market governments have to repay roughly $86 billion in U.S. dollar bonds by the end of next year, according to data from Dealogic. A United Nations agency urged the Fed and other central banks Monday to halt rate increases, warning that “alarm bells are ringing most for developing countries, many of which are edging closer to debt default.”

Pension pain

Financial upheaval often happens in unexpected places, where bankers and regulators are unprepared or where they think markets are well-insulated.

The turmoil in Britain involved pensions and government debts, long thought to be among the safest parts of the financial markets. The government on Sept. 23 announced a package of tax cuts that would have added significantly to deficits. In response, the pound sank to a record low against the dollar, and yields on British bonds, known as gilts, shot up.

The rise in yields was amplified by derivative instruments loaded with hidden debt, part of a strategy by U.K. pension funds called “liability-driven investments,” or LDIs.

Derivatives can be used to hedge risk or amplify returns. LDIs were designed to do both: protect pensions from low interest rates by constructing cheap hedges, while freeing up cash to invest in higher-yielding assets. British pension regulators encouraged plans to adopt LDI strategies despite signs that some had become dangerously exposed to interest-rate changes.

As interest rates rose, pension funds were exposed to losses and margin calls, demands for cash to cover the risk of more losses. To cover margin calls, managers sold assets, in many cases even more gilts. The selling pushed interest rates higher, in a liquidation spiral.

It had echoes of forced selling that figured in past crises, including the 1987 stock-market crash, the 1994 bond-market selloff that bankrupted Orange County, Calif., the 1998 Russia default and the 2007-09 global financial crisis.

The Bank of England last week stepped in with a plan to buy gilts to relieve the pressure on pension funds. On Monday, the government backtracked and said it was dropping one of its planned tax cuts.

Now, banks and governments around the world are grappling with how to interpret last week’s events. Some experts say the signs so far don’t point to disaster.

U.S. corporate pension plans managed by consulting firm and insurance brokerage Willis Towers Watson have posted tens of millions of dollars in collateral to address margin calls this year, said portfolio manager John Delaney of Willis Towers Watson. But the strategy and the resulting margin calls are on a far smaller scale than in the U.K., where derivatives are more prevalent and pension plans tend to be bigger relative to company size, he said.

Some U.S. public pension plans are vulnerable to margin calls. These plans used derivatives to substitute for bonds in their portfolio and increase the total amount they could invest to boost returns. The pensions adopted the strategy because low interest rates weren’t generating enough returns to pay promised benefits.

Rate climb

Central bank tightening is often behind financial disruption because of its effect on short-term interest rates. When those rates are low, investors will often borrow short-term funds to take on more risk for the prospect of higher returns. As rates rise, they have a harder time financing their positions.

In 1994, the Fed surprised investors with a three-quarter percentage point rate increase to 5.5%. Financial managers for Orange County had investment positions that depended on low interest rates and the county went bankrupt.

From 2004 to 2006, the Fed pushed up rates in quarter percentage point increments to 5.25% from 1%. Yet even that eventually undermined housing demand and prices, triggering a crisis among financial institutions that had invested heavily in mortgages and related products.

The Fed and other central banks are now tightening much more aggressively than in past years because of high inflation. Since March, the Fed has raised its benchmark rate from near zero to more than 3% and signalled it will top 4% by year-end.

The moves have pushed mortgage rates to their highest levels since 2007, raising concerns about a freeze in mortgage transactions and an even deeper downturn that chills demand for existing housing and new construction. But nothing on the scale of 2007-09 seems likely. U.S. mortgage debt has grown only 14% since 2007, most of it to much more creditworthy borrowers.

More worrisome, economists say, is the 332% increase in outstanding Treasury debt during the same period, to $26.2 trillion.

Like the U.K., the U.S. borrows in a currency it can also print. That means there is no risk of default, as there is with corporate, emerging-market or mortgage debt, the cause of many past crises. Printing currency to pay federal debt, however, risks causing more inflation.

Bankers and regulators worry that Treasury debt is outgrowing Wall Street’s willingness or ability to trade in it. Inflation and Fed rate increases are adding to bond-market volatility, putting a strain on market functions.

Banks designated by the Fed to transact in newly issued government securities, known as primary dealers, buy and sell with their own money to keep markets moving smoothly. The volume of Treasury debt held by these banks has shrunk to less than 1% of all outstanding Treasury debt, according to JPMorgan Chase & Co.

This makes it more difficult for investors to buy or sell Treasurys with the volume, speed and at prices they have come to expect. That is a problem because of the market’s importance to the broader functioning of the credit system. In March 2020, for example, as the Fed was cutting short-term interest rates to help the economy, Treasury yields were rising, a result of unexpected selling by investors needing to raise cash as well as dysfunction in the market. The Fed stepped in and bought vast quantities of the debt.

By one measure—how much debt can be traded at a given price—market functioning today is as bad as it was in April 2020, in the depth of pandemic lockdowns, according to JPMorgan. By another measure, this year has seen the worst conditions since 2010, according to Piper Sandler & Co.

The morning after the Sept. 21 Fed meeting, Treasury yields shot up. The 10-year yield jumped to more than 3.7% from around 3.55% in less than two hours.

Roberto Perli, a central bank expert at Piper Sandler noted a growing gap between the yields on the easily traded Treasurys and others, a sign of more difficult trading conditions. “The capacity of dealers to make orderly markets has diminished,” he said.

Treasury officials said they don’t see a reason for alarm, but trading conditions are a problem they are watching. “Reduced market liquidity has served as a daily reminder that we need to be vigilant in monitoring market risks,” Nellie Liang, Treasury undersecretary for domestic finance, said last month.

Two once-reliable sources of demand for Treasurys, banks and foreign investors, are pulling back.

U.S. commercial banks increased their holdings of Treasury and agency securities other than mortgage bonds by nearly $750 billion over the course of 2020 and 2021, partly to invest a pandemic-induced surge in deposits. This year, as customers have shifted deposits to such alternatives as money-market funds, that figure has shrunk by about $70 billion since June.

For years, Treasurys were among the few advanced-economy bond markets with positive yields, making them attractive to foreign investors and a haven during moments of market turmoil. Now, other government bonds’ yields are rising, giving foreign investors more options.

Added to these strains, the Fed itself has stopped a bond-buying program launched during the pandemic to support markets and the economy.

“We worry that in the Treasury market today, given its fragility, any type of large shock really runs the risk of un-anchoring Treasury yields,” said Mark Cabana, head of U.S. rates strategy at Bank of America.

—Heather Gillers contributed to this article.



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Clocking out to Turn Back Time—Vacations That Will Help You Live Longer
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Booming demand for wellness tourism shows no slowing, with travel related to health and well-being projected to have reached $1 trillion last year and to hit $1.3 trillion by 2025, according to the Global Wellness Institute, a nonprofit based in Miami.

Curated wellness travel programs are especially sought-after, specifically holistic treatments focused on longevity. Affluent travellers not only are making time to hit the gym while gallivanting across the globe, they’re also seeking destinations that specifically cater to their wellness goals, including treatments aimed at living longer.

“I believe Covid did put a spotlight on self-care and well-being,” says Penny Kriel, corporate director of spa and wellness at Salamander Collection, a group of luxury properties in places like Washington, D.C., and Charleston, South Carolina. But Kriel says today’s spas are more holistic, encouraging folks to understand the wellness concept and incorporate it into their lifestyle more frequently.

“With the evolution of treatment products and technology, spas have been able to enhance their offerings and appeal to more travellers,” Kriel says.

While some growth is connected to the variety of treatments available, results and the digital world are also contributing to the wellness boom.

“The efficacy and benefits of these treatments continue to drive bookings and interest, especially with the support of social media, influencers, and celebrity endorsements,” Kriel says.

While genetics, environmental factors, and lifestyle choices such as regular exercise, a diet free of processed foods, sufficient sleep, and human connection play essential roles in living well and longer, experts believe in holistic therapies to help manage stress, boost immunity, and ultimately influence length and quality of life.

Anti Ageing and Beyond

“For years, people have been coming to spas, booking treatments, and gaining advice on how to turn the clock back with anti ageing and corrective skin treatments,” Kriel says. However, today’s treatments are far more innovative.

On Marinella Beach in Porto Rotondo, on the Italian island of Sardinia, guests at the five-star Abi d’Oru Hotel & Spa can experience the resort’s one-of-a-kind “longevity treatment,” a unique antiaging facial using one of the island’s native grapes: Cannonau. The world’s first declared “Blue Zone”—one of five designated areas where people live longer than average, some into their 100s—Sardinia produces this robust red wine varietal, the most widely planted on the island.

Known as Garnacha in Spain and Grenache in France, Cannonau supposedly contains two to three times more antioxidants than other red-wine grapes. By incorporating Cannonau, Abi Spa says its unique 50-minute longevity session increases collagen production for firmer, younger-looking skin.

Maintaining a youthful appearance is just one facet of longevity treatments, which range from stress-reduction sessions like massage to nutritional support and sleep programs, Kriel says. Some retreats also offer medical services such as IV infusions and joint injections.

Keeping with the trend, Kriel is expanding Salamander Collection’s existing spa services, such as detox wraps and lymphatic drainage, to include dedicated “Wellness Rooms,” new vegan and vegetarian menu items, and well-being workshops. “Sleep, nutrition, and mindfulness will be a big focus for integration in 2024,” she says.

Data-Driven Wellness

Skyler Stillings, an exercise physiologist at Sensei Lanai, a Four Seasons Resort—an adults-only wellness centre in Lanai, Hawaii—says guests were drawn to the social aspect when the spa opened in November 2021.

“We saw a huge need for human connection,” she recalls. But over the past few years, what’s paramount has shifted. “Longevity is trending much more right now.”

Human connection is a central draw for guests at Sensei Lanai, an adults-only and wellness-focused Four Seasons Resort in Hawaii.
Sensei Lanai, A Four Seasons Resort

Billionaire co-founder of tech company Oracle Larry Ellison and physician and scientist Dr. David Angus co-founded Sensei. After the death of a mutual close friend, the duo teamed up to create longevity-based wellness retreats to nurture preventative care and a healthy lifestyle. In addition to the Lanai location, the brand established Sensei Porcupine Creek in Greater Palm Springs, California, in November 2022.

Sensei has a data-driven approach. The team performs a series of assessments to obtain a clearer picture of a guest’s health, making wellness recommendations based on the findings. While Sensei analyses that data to curate a personalised plan, Stillings says it’s up to the guests which path they choose.

Sensei’s core three-day retreat is a “Guided Wellness Experience.” For spa treatments, each guest checks into their own “Spa Hale,” a private 1,000-square-foot bungalow furnished with an infrared sauna, a steam shower, a soaking tub, and plunge pools. The latest therapies include Sarga Bodywalking—a barefoot myofascial release massage, and “Four Hands in Harmony,” a massage with two therapists working in tandem. Sensei Guides provide take-home plans so guests can continue their wellness journeys after the spa.

Sensei Lanai, an adults-only and wellness-focused Four Seasons Resort in Hawaii.
Sensei Lanai, A Four Seasons Resort

Sanctuaries for Longevity

Headquartered in Switzerland with hotels and on-site spas across the globe, Aman Resorts features an integrative approach, combining traditional remedies with modern medicine’s advanced technologies. Tucked behind the doors of the storied Crown Building in Midtown Manhattan, Banya Spa House at Aman New York—the brand’s flagship spa in the Western Hemisphere—is a 25,000-square-foot, three-floor urban oasis.

Yuki Kiyono, global head of health and wellness development at Aman, says the centre provides access to holistic and cutting-edge treatments benefiting physical, mental, emotional, spiritual, and social well-being. Aman’s customisable “Immersion Programs” consist of a three- or five-day immersion. “The programs encompass treatments and experiences that touch every significant aspect to create a path for longevity, from meditation and mindfulness to nutrition and movement,” Kiyono explains.

Banya Spa House at Aman New York.
Robert Rieger

The spa’s “Tei-An Wellness Solution” features 90- to 150-minute sessions using massage, cryotherapy, and Vitamin IV infusions. Acupuncture is also on offer.

“With its rich history of Chinese Medicine, modern research, and the introduction of sophisticated electro-acupuncture medicine, acupuncture has been proven to assist with problems and increase performance,” Kiyono says.

Resetting the Mind and Body

Beyond longevity, “healthspan”—the number of years a person can live in good health free of chronic disease—is the cornerstone of Mountain Trek Health Reset Retreat’s program in British Columbia, Canada.

Kirk Shave, president and program director, and his team employ a holistic approach, using lifestyles in long-living Blue Zones as a point of reference.

“We improve our daily lifestyle habits, so we live vitally as long as we’re meant to live,” Shave says of the retreat. He built the program from an anthropological stance, referencing humans as farmers, hunters, and gatherers based on their eating and sleeping patterns. Food includes vegetable-centric meals sans alcohol, sugar, bread, or dairy.

Guests wake at dawn each day and have access to sunrise yoga, several hours of “flow” or slow hiking, spa treatments, forest bathing, calming crystal singing-bowl and sound therapy sessions, and classes on stress reduction—one of Mountain Trek’s primary goals. The program motivates people to spend much of their time in nature because it’s been proven to reduce cortisol, the stress hormone that can lead to inflammation and disease when elevated for extended periods.

While most guests aren’t aware of how immersive Mountain Trek’s program is when they arrive, they leave the resort revitalized after the structured, one-week program. Set in the Kootenays overlooking its eponymous river, the resort and adventure promise what Shave calls a “visceral experience of transformation.”

“They’re interested in coming to be in nature,” Shave says of the guests. “They hit a wall in their life and slipped backwards, so they know they need a reset.”

Banya Spa House at Aman New York provides access to holistic and cutting-edge treatments benefiting physical, mental, emotional, spiritual, and social well-being.
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This article first appeared in the Winter 2024 issue of Mansion Global Experience Luxury.

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