Phil Cannella Explains The Domino Effect in Bond Markets

Each week on The Crash Proof Retirement Show, Phil Cannella takes time to talk about safe alternatives to the risk of Wall Street. This week’s lesson was about the volatility of the bond environment, a lesson the city of Chicago is learning as we speak.

Research from Retirement Media Inc. found that Moody’s, a leading provider of credit ratings, research, and risk analysis, has downgraded the credit rating of America’s 3rd-largest city to junk-bond levels. Moody’s rating system, which grades bonds from Aaa to C, makes a distinction between investment-grade and junk level bonds between Baa and Ba, the exact fall-off that Chicago’s credit experienced.

This is just the latest setback in a series of events that has engulfed Chicago—and the state of Illinois as a whole. “What many investors and everyday Americans don’t realize is that interest rates have been down for 10 years,” said Phil Cannella. “That environment affects the bond environment.”

When interest rates moves lower, bond values increase—accordingly, bond values have been up for the past decade. However, the reverse is also true. When interest rates start to increase, bond values will be depressed.

The Domino Effect

A full decade without an increase in interest rates in unprecedented in the American economy—and as Phil Cannella pointed out, that run is most likely nearing an end sometime in 2015.

“The bond industry is in a bubble right now,” Phil summarized, “and when those interest rates go up, it’ll be like a sharp pin, popping that bubble.”

“And in my opinion, this becomes a domino effect,” Cannella continued.”We’ll see this happen in city after city.”

In making the announcement, Moody’s said they saw a negative future outlook for Chicago’s credit, citing a recent Illinois court ruling voiding state pension reforms. Adding to the problem were the words of Illinois Governor Bruce Rauner, who said last Wednesday that no bailout money will be coming from the state government to help Chicago. That’s because the state of Illinois is locked in what Governor Rauner calls a “terrible financial crisis” of its own.

What’s Next?

Experts said the downgrades in credit ratings could trigger upwards of $2 billion in accelerated debt payments. But that’s going to be a big problem, because according to CNBC, the city and state are underfunded by $130 billion!

Of course, the municipal bond crisis really got started two years ago, when Detroit became the largest U.S. city to declare bankruptcy. Since then, cities such as Stockton, CA have filed for protection from bankruptcy.

But a crisis in Chicago—again, the country’s third largest city—would take things to an entire new level. “It looks like some sleepless nights are in store for municipal bond holders,” Phil Cannella summarized.