Interest Rates: Levels to Watch

04/08/2015 9:00 am EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

The global economy is in uncharted waters. The central banks seem to be improvising as they go along, hoping all goes well, asserts Mary Anne and Pamela Aden, editors of The Aden Forecast.

But no one really knows how this is all going to work out. That’s not good or bad, it’s just because it’s never happened before.

Currently, about ten countries have interest rates below zero. That is, they have negative interest rates, which means you have to pay the bank to keep your money. This is unprecedented going back 800 years.

The past 100 years have seen the highest and the lowest interest rates ever recorded in world history. We think this is truly amazing and a little scary. It’s something most people don’t realize and it’s a super wild card.

The debate rages on. And it’s become so heated, it’s almost ridiculous, and so is the debate’s foundation. Why? Because it's all based on innuendos and what the Fed may or may not do in the future.

More specifically, will they be raising US interest rates sooner or later? That’s the big deal and the anticipation it’s creating has been one of the key factors moving the markets.

On the one hand, we have Team A. They’re a large majority who are certain interest rates will be rising by June.

They point out the better economic signs as evidence the economy is standing on its own and it’s strong enough to endure higher interest rates. They also interpret the Fed’s recent comments as more evidence the Fed’s ready to move ahead.

The bond bubble is another big reason why interest rates will likely head higher by mid-year, argues Team A. After all, bonds have already been rising for a very long time.

Furthermore, how low can interest rates go? Long-term rates are near 2% and the Fed funds rate has been near zero for over six years. This tells them the bond bubble is going to pop any time.

On the other hand, there’s Team B. They believe interest rates will not be rising any time soon. They see that interest rates are below zero in many of the major countries. They’re also seeing more signs of deflation and they don’t believe the Fed can raise interest rates in the current environment.

That’s especially true considering that US inflation turned negative over the past 12 months for the first time since 2009. Even the core inflation rate, which removes food and energy costs, is on the decline.

That’s far below the Fed’s 2% inflation target, which doesn’t bode well for an interest rate hike any time in the months ahead.

As you know, we’ve been in the Team B camp for a long time, basically ever since we recommended buying bonds over a year ago. But now we’re moving to the middle ground. This is based on the recent upmove in interest rates and what our charts are telling us.

The real test will come if the 30-year yield now stays above its 15-week moving average; this average has been very reliable, coinciding with the downtrend in interest rates since early 2014 (the rise in bond prices).

This moving average is now at 2.66%. So, an ongoing rise above that level for the 30-year yield would be the first signal that the bull market in bonds may be coming to an end.

This would be reinforced if the 30-year yield rises above 3.25% (its 65-week moving average). For the 10-year yield, the equivalent level would be a rise above 2.47%. But, even if the yield rose that high, it would still be in a clear downtrend since 2008.

That is, interest rate rises to the 65-week moving averages, while dramatic, would not necessarily confirm that this big bull market is over. In fact, it’s more likely that we could see a repeat of the previous two interest rate declines.

If so, then interest rates could have one more big drop before they finally hit bottom, like they did in 2011-12 and 2007-2008. Of course, there are no guaranties.

So, we’ll have to stay tuned and see how things unfold in the weeks ahead. But for now, US government bonds remain strong, bullish, and internationally attractive. So stay with them.

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