With the continuous record highs being set in the stock market and crypto market people might wonder where to find a bear. Tim Knight at Slope of Hope might be the last bear left on the planet. The rest have gone into hibernation. However, if you are a bear you might take a peek at US Treasuries. I think things are heating up there finally.
To give you some context, interest rates have been zero or near zero since the financial crisis in 2008. People that grew up in my generation have lived through two extremes in interest rates. In the 1970’s and early 1980’s they were extremely high with three-month T-Bills hitting 21% at one point. Since 2008, basically 0%. QE was necessary the first time, perhaps the second. Since then it has been a dangerous game and has changed risk-reward ratios in many asset classes. Combined with the explosion of the deficit it’s even more dangerous.
The way around it is to create sustained economic growth. The drop in corporate taxes ought to help here which is why the Congressional Budget Office projections should be used to line a birdcage. The truth is no one knows what the rate of growth will be given the drop in taxes.
They pinned me down and forced me to give them a target for my year-end close in the 10-YEAR TREASURY. So, in respect to one of the blog regular BIGMAN, I will state here that my year-end target is 3.4%. If I am correct I will buy the bottle of PAPPY VAN WINKLE to celebrate. My target is not based on inflation but rather on the incoming FED Chair Jerome Powell. In last weeks FOMC transcript from September 2012, the meeting results revealed that Powell was very uncomfortable with increasing the FED’S QE program because he worried about the size of the balance sheet and how would the FOMC be able to exit from the massive build-up of assets.
The discount rate is 2% today. It was 1.25% a year ago. The current 10-year Treasury rate is 2.55%. Since rates move in the inverse of price, it would be a nice bear move if it went to 3.4%.
The rally in the stock market and the decrease in corporate taxes gives the Fed plenty of room to raise rates. When they do, I think it will have ripple effects in places that people aren’t immediately thinking about. The obvious ones are real estate and land values. As rates go up, price appreciation slows down in those kinds of assets. Commodity prices could also appreciate less because of the interest charges tied to holding them. The rally in stocks should temper as the trade-off between holding a risky asset versus a treasury return to more historical norms. The price of corporate bonds could suffer. The cost for municipalities to auction off debt will go up. When cities have to pay more for their debt, it adversely affects taxpayers. Volatility should increase in stock markets so if you consistently short the VIX you might be in for a surprise.
The interesting thing to watch will be cryptos and the valuations of startup companies. I really believe 0% interest rate policies have had an effect here. Increasing interest rates might let a little of the gas out of the crypto bubble. Increasing rates combined with a new trend of a distaste for early-stage investing will hurt valuations of startups.
I think Yra better save some money to buy himself some Pappy Van Winkle. I’ll bring the glasses.