Interest rates have been surging, hitting three year highs, and they’re at a critical juncture, caution Mary Anne and Pamela Aden, economic experts and editors of The Aden Forecast.
The Fed is getting backed into a corner. The last time this happened was in the 1970s. At that time, Fed Chief Volcker raised interest rates to 20% to halt inflation. This resulted in two recessions and lower inflation.
Currently, despite what they say, there are no signs the Fed can or will do something similar. It would simply be devastating with many negative consequences, like a huge recession, bankruptcies, foreclosures and more. And it would result in social unrest, like we’re beginning to see in other countries.
Interest rates are one of the most important markets in the world. They’re the movers and shakers, and the other markets generally react to what they’re doing. The same is true of the economy.
Remember, low interest rates have been standard policy for the past 14 years. That’s also been the case with QE, which has essentially been creating money ongoing to keep the economy moving along. But then covid came on the scene and the situation intensified.
In reaction to covid, the economy plunged and the Fed printed way too much money. The Fed’s balance sheet soared nearly $4 trillion. This was more than the total accumulated over the past 100 years or so.
In other words, the Fed’s balance sheet has doubled and it’s now at $9 trillion. Currently, the Fed is trying to bring this down by letting their bonds expire, which they bought during QE. This is a form of tightening and so are rising interest rates. This is already putting downward pressure on stocks.
Signs of recession are also beginning to emerge and no one wants a recession. Nevertheless, recession hangs over the world. In China, for instance, covid lock downs continue and this alone will lead to more global stress. Plus, Fed Chairman Powell warned the war in Ukraine could impact the economy as well.
If push comes to shove, we’re fairly sure the Fed will do an about-face and reverse their monetary and interest rate position from tightening to accommodating — at least this is what our leading indicators are telling us.
Keep in mind, if the Fed is able to see 2% on the Fed funds rate, it’ll force interest payments on the Fed debt to rise over $1 trillion. The resulting political feedback would force the Fed to retreat and throw the credibility of Treasury debt and the dollar into doubt.
The long-term rate has been declining since the early 1980s. The 80-month moving average is the mega trend identifier and it’s now at 2.48%. There are times, however, when the 30 year rate has overshot above the average, like in 2018, but it then came back down. That’s likely what’s currently happening. That is, the upside is limited even if the 3% level is tested.
The 10 year yield is similar. But in this case, the leading (medium-term) indicator is also too high. This is signaling that long-term interest rates are unlikely to rise much further and they’ll soon turn down. So all things considered, we bought bonds prematurely. But, as disappointing as they’ve been, all of these factors are telling us it’s best to ride it through because long-term rates will be coming down, looking over the valley.
It may not happen right away, but it’ll likely be sooner rather than later. We own three ETFs for exposure to bonds: iShares TIPS Bond ETF (TIP), iShares 20 Plus Year Treasury Bond ETF (TLT), and SPDR Portfolio Long Term Treasury (SPTL). Keep your long-term U.S. government bonds and the bond funds for now.
