It’s been week since a blowout jobs report set fire to financial markets and signaled that everything is about to change. Barataria predicted a good report, if very timidly, and gave everything a week to shake out. So where do we stand a week from the first clear signal liftoff is occurring?
The short answer is that markets have absorbed the reality of a rising Fed Funds Rate. The long answer is that it sure doesn’t look like it for a lot of reasons which are complicated and confusing. In an increasingly smaller world there is nothing that confines money to one “market”, meaning that pressure is on from all directions.
The upshot is that after an initial spike there is reason to believe a rise in interest rates by the Fed may yet trigger a net medium-term fall in interest rates paid by consumers, as predicted. It’s worth explaining further.
In the last week the S&P500 has fallen 48, or about 2.3%. That was to be expected as the reality of higher rates set in, but it points to the first pressure on interest rates. The money leaving stocks has to go somewhere, and the safety of US Treasuries is the most likely place.
The problem is no one wants to go there yet because rising interest rates mean falling bond prices. The way the bond market works is that any bond owned by an investor pays a fixed interest payment. The only way to make that fixed number go up in a regime of rising interest rates is if the price of the bond goes down. It doesn’t seem like a smart investment.
This is where it gets interesting. After a jump from 2.25% to 2.34% by Monday the benchmark 10yr Treasury drifted down to 2.32%. As many market watchers have observed there seems to be an upside cap on interest rates which have been trending only downward for years.
On Thursday 12 November a number of Fed officials clarified where they stand ahead of the December Fed Open Market Committee (FOMC) meeting where they will decide on a rate increase. The consensus is that rates will rise slowly after the initial lift-off, which is to say there will be a rise in December. The “doves” who favor low rates have clearly capitulated.
That’s why other financial writers feel a rate rise simply isn’t priced into the market yet – an argument which makes no sense on the face of it. It’s not like any of this is a surprise and the movement of US stocks in particular shows that investors are generally responding as they should. What’s going on?
The answer is in the new dovish position – rates will rise slowly.
Interest rates in Europe are also at zero, but a round of “quantitative easing” which started at €1.1 trillion may only expand. That means money will be cheap in Europe for a while yet. The last time the US tightened money and Europe did not was in 1994, and the effects were strange at best. None of the expected results, which were a rising US Dollar and an increase flow of money from cheap (Europe) to higher rates (US) materialized for about two years.
If anything that “carry trade” between currencies will only be stronger twenty-some years on.
That means there is quite a bit of downward pressure on the US Dollar despite the increase in interest rates – which otherwise should raise the value of our currency. Combine this with a determination to go at this slowly and deliberately we have a strong pronouncement from the central banks that nothing too crazy is about to happen.
The pressure on US rates? Certainly not as upwards as anyone might expect. Where it gets interesting is when the slow rise makes the risk of holding bonds low enough that the safe haven seekers flood into bonds.
Where will this money come from? All around the world. Those who borrowed in US Dollars when our rates were low are being given time for a smart, orderly exit from markets like China and Brazil. Money may well find its way back to US Treasuries, lowering rates.
The mark at the start of this was 2.25%. We’re still higher, but look for that to be breached in the next month. When the reality that a higher Fed Funds rate may actually mean lower rates for everyone it’ll be time to look out. It’s probably not a good time to hold US stocks.
Good analysis. Thanks. (any idea about gold?)
I’m still bearish as all Hell on gold. Even if the US Dollar doesn’t appreciate I see it going nowhere but down – a trajectory it recently picked up again after a brief spike up during the August – September market volatility.
I see the price of gold as nothing more than an indicator of fear, and I see fear subsiding through the next several years.
We can only wait and see what happens.
Last I looked the 10 year treasury was at 2.28% as the market is down. Good call!
It’s tanking quicker than I expected – much quicker than the stock market. We might breach 2.25% today or on Monday at this rate. But the call is for below 2.00% as the dust settles early in 2016. That will be good for everyone.
None of this makes any sense but you seem to have something here.
It only makes sense when you think about $9 trillion in “carry trade”, or US Dollars loaned out in the developing world, that has to come home once things start normalizing. The key is to follow the money and look for something to break – which it is (slowly) now.
Do you need Supergirl’s number for any “save the day” type things? Let us know and I contact her for today’s code. ; )
Remember, Lord, those who have died and have gone before us marked with the sign of faith, especially those for whom we now pray, the fallen in Paris France. May these, and all who sleep in Christ, find in your presence light, happiness, and peace. [Through Christ our Lord. Amen.]
For ourselves, too, we ask some share in the fellowship of your apostles and martyrs, with John the Baptist, Stephen, Matthias, Barnabas, [Ignatius, Alexander, Marcellinus, Peter, Felicity, Perpetua, Agatha, Lucy, Agnes, Cecilia, Anastasia] and all the saints. Though we are sinners, we trust in your mercy and love. Do not consider what we truly deserve, but grant us your forgiveness. Through Christ our Lord.
Through him you give us all these gifts. You fill them with life and goodness, you bless them and make them holy.
Did you even give thought to the idea that some of the victims might have been Jewish?
Sorry. That was for those who like that prayer.
Let us pray
brothers and sisters
Recalling our common humanity and spirituality
That Holy God
God of Justice Love and Mercy
Will receive into eternal and tender care
The souls of the innocents
Who died in Paris yesterday.
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