Interest rates

Where could interest rates peak?

Picking interest rate lows and highs is a lot more complicated than trying to pick stock market lows and highs, but this chart will give us some levels of performance, focusing on the last decade or since 2010 .

What’s unusual over the past 14 years – 2008 to 2022 – is that we (investors, Americans, etc.) have now had two separate periods of zero fed funds rates over that period, and I wonder whether this is now the norm or whether the next 10 years means investors see progressively higher interest rates and a reversion to the mean so to speak, which will influence not only market valuation but also home loans and automobiles and consumer credit.

The three interesting levels of the last decade are the following points:

  • the 4.01% return achieved in January 2010, after the rebound from the generational low of March 9, 2009 for the S&P 500;
  • The 3.04% yield hit in January 2014, following the Bernanke Taper Tantrum, after which President Obama replaced Bernanke with Janet Yellen in January 2014 as Fed chair, guaranteeing that her term would see higher rates. zero interest until leaving office;
  • The 3.24% yield was achieved in October 2018 during Powell’s Fed Funds tightening regime under the Trump administration, which ended in December 2018, January 2019;

My own estimate is that the yield will hit 3% again if Jay Powell moves the fed funds 50 basis points at the May 22 meeting and begins quantitative tightening at the same time. Above 3.24% – 3.25% on the 10-year Treasury, and we could be in a new interest rate paradigm.

Monthly chart of 10-year treasury bill yield

While the mainstream financial media is reporting 7% to 8%, the fact is that the 10-year Treasury yield at 2.85% tells us that inflation is temporary, so either the bond market is very, very bad or inflation decreases in the next 8 months. (Most retail investors don’t understand the concept of “real” treasury yields and that over the past 50 years, up to the last 12 years, the real yield on treasuries averaged 2 %, so individual investors who own Treasuries today are earning negative real returns through inflation.)

Summary

My opinion is that – after 2008 – and the housing and stock market deflation that happened that decade (from 2000 to 2009), the Federal Reserve wanted some inflation. Deflation is much worse than inflation since it discourages consumption and the creation of wealth. It’s finally 2022, and the US population is experiencing real inflation, and that’s probably a good thing. Bond market investors – especially those my age – have only experienced the steady decline in interest rates since the early 1980s.

Are we in a new paradigm for interest rates? It is too early to tell. What is the “true” rate of inflation today? It is probably in the 3% high – 4% low zone, implying that the 10-year Treasury yield is still overvalued, but not as much as the headlines would suggest.

Clients underweight duration with their bonds and fixed income out of 2020. Duration of higher quality corporate bond funds like LQD and AGG were around 9 years at the end of 2021, so a high short-term return ETFs like SHYG were perfect for clients to get a return and limit interest rate risk, with its 4.5-year duration.

If the early March 22 peak at $131 was the top (and many good techs believe it was), I think that matters for the bond market. Tom Lee and Fundstrat wrote that gasoline is now only 3% of the average household budget, but I think crude and gasoline are the face of inflation and are psychologically significant to the average American.

If Jay Powell acts aggressively at the May 22 Fed meeting and the 10-year Treasury yield can’t clear that 3% to 3.25% peak, it’s probably time to extend the maturity and the duration.