Interest Rates Poised To Turn Higher?
Recently, we described the unusual relationship between inflation, GDP, and interest rates in “Inflection Point (Part 5): Interest Rates, Inflation, and Inflection” (https://markonomics101.com/2018/09/03/inflection-point-part-5-interest-rates-inflation-and-inflection/). It is vital that investors understand the accuracy and quality of “official” numbers regarding economic performance, especially in making investment decisions.
The Bureau of Labor Statistics reported annual inflation number of 2.9% seems very low when one compares it to anecdotal evidence. Major expense items such as health care, housing, energy, education, and entertainment are far outstripping this reported number.
Interest rates, which are largely based on inflation, are set by lenders and borrowers to compensate the lender for lost purchasing power and provide a small “real return” of typically 1-2% or so. No one wants to lend at a guaranteed loss.
The current interest rate structure is below 3% for maturities of greater than 5 years, enough to compensate for the measure of inflation called the Consumer Price Index or CPI of 2.9% but nothing more. A lender to Uncle Sam would receive no “real return” and probably be undercompensated for inflation. Why? One possibility is that the Federal Reserve is a large enough buyer to keep yields low. Another possibility, although very unlikely, is the economy is so weak that investors believe inflation will actually be more like 1.5% and are therefore provided with a return.
The Federal Government is highly incentivized to underreport inflation. For a more thorough discussion as to why, please review (https://markonomics101.com/2018/09/03/inflection-point-part-5-interest-rates-inflation-and-inflection/).
Over the last several trading days, yields on the 5 Year, 10 Year, and 30 Year Treasuries have advanced sufficiently to be challenging major resistance and to be hinting at a break out from Triangle Patterns. If they all break above 3.25% they will have established a NEW UP TREND and with it, a RISING INTEREST RATE environment. The emerging trend of higher rates will have overtaken the dying trend of falling rates. The Inflection is complete and ushers in the Tipping Point.
To illustrate how close we are to completing the Inflection, let these pictures do the talking.
The yield of the 5 Year and the 10 Year Treasuries are at the top of Triangle Patterns. The 30 Treasury has been kept at or below 3.25 % for nearly 4 years. Each of these Patterns suggest that the Treasury Yield structure of 3% will not hold for much longer. To clarify the charts, HIGHER RATES mean LOWER BOND PRICES and are, therefore also BEARISH.
Even a modest rise in rates to 6% would have a substantially adverse effect on paper assets. When one also factors in the danger signs present in the Major World Markets (https://markonomics101.com/2018/09/09/tipping-point-part-4-major-world-equity-market-poised-for-decline/ and US Markets (https://markonomics101.com/2018/08/31/ultra-high-risk-for-equities/), the possibility of severe financial damage is too high to be ignored. The Risk of holding market equities at the current time is Substantial.
“Take Your Money off the Table, before the Table takes Your Money Off of You”. Mr. Market lets you win for a while, but just when you think you have all the answers, he changes the questions.
Keep in mind, that the purpose of these missives is not to sell you anything but to provide you with a set of facts and data that can only help you. If you disagree, feel free to leave a comment. If you can add to the publication by providing information we left out, we welcome it.
A scenario where the markets go higher and interest rates lower is certainly plausible but how much upside could you expect and how much risk would you be taking? The Inflection appears to be nearing completion and any Investor or Trader will need to be flexible enough to prosper within the new rules. Most are not.
The good news is that for those that can step back, this horrible World Bear Market will be rife with opportunities.