Sounds crazy, I know. But that’s precisely what is happening in the market. And that begs the question: “What are interest rates trying to tell us?”
Before I provide some possible answers, let’s cover some important background information. When the Fed says it will “raise rates,” it doesn’t raise every single rate in the market. It can only directly control a couple of very short-term rates.
The main benchmark is the federal funds rate, which is an overnight rate at which banks borrow money from each other. The other rate is the discount rate, the rate at which banks borrow directly from the Fed on a short-term basis. The Fed hiked both by 25 basis points, or a quarter of a percentage point, last week.
|The Fed raises interest rates and interest rates go … down? What’s going on?|
The level of all other rates is a function of supply and demand in the marketplace. If investors really, really want to own, say, 30-year Treasury bonds, their buying will drive bond prices up and bond yields down — regardless of what the Fed says or does.
Sure enough, they’ve been buying the heck out of ’em since the Fed moved. The iShares 20+ Year Treasury Bond ETF (TLT) is a solid proxy for longer-term bonds, and you can see it has risen in price the past few days. Since yields move in the opposite direction of prices, we’ve seen the 30-year Treasury yield fall to as low as 2.89% today from an intraday high of 3.03% on Fed day.
What’s more, the “2-10 spread” has collapsed in the wake of the Fed move. That is simply the difference between the yield on the 2-year Treasury Note and the yield on the 10-year Treasury Note. At 124 basis points, or 1.24 percentage points, it’s hovering around its lowest level in eight years as you can see in this chart:
|The lowest level in years.|
This isn’t normal behavior for the beginning of a Fed rate-hiking cycle. Typically you see almost all interest rates rise in the early stages of a cycle. Then later on in the cycle, if investors get worried the Fed is overdoing the hikes and threatening to crush the economy and inflation, longer-term yields fall and spreads compress dramatically.
So why is it happening now? My leading theory is that investors are worried the Fed is making a policy mistake. They believe the Fed either shouldn’t have hiked at all, or fear the Fed waited too long to start the hiking cycle. Now, the theory goes, the Fed is hiking into the teeth of a credit market collapse and sharp slowdown in the economy.
That would explain why investors are flocking to all kinds of short-term, intermediate-term, and longer-term Treasuries. They usually rise in price, and fall in yield, when the economy slumps and investors are looking for “safe haven” plays. It would also explain why interest rate spreads are compressing.
|“This isn’t normal behavior for the beginning of a Fed rate-hiking cycle.”|
It’s true that interest rate investors can be just as wrong as stock traders sometimes. If the economic and inflation data get much stronger in the weeks ahead, these trends may reverse.
But I have my doubts about that outcome. I’ve been very worried about a major turn in the credit and economic cycles for months, and haven’t been shy about sharing those concerns here. I wouldn’t be surprised if these nascent interest rate market trends get even worse as we head into 2016 — and that has significant implications for your wealth and investing strategy.
I’ve shared some of my general investment themes and ideas here. I provide specifics, including “buy” and “sell” signals, in my Safe Money Report service. I’ll be covering these topics in great detail in my first issue of 2016, which will go to press early in the new year.
Meanwhile, I’m interested in your thoughts on interest rates. Is the market trying to tell us something about the outlook for stocks and the economy? Is the Fed making a policy mistake? Or are rate investors worried about a phantom threat, one that will dissipate with the passage of time? Hit up the comment section below to add your views.
We had a heck of a tumble late last week, and I asked in my Friday piece who you blamed and why.
In response, Reader Kevin R. said: “The monetary system is being run and ruined by incompetent fools, buffoons, and crooks. Along with the crooks on Wall Street, they are collapsing what’s left of our system, our lives, and our sanity.”
Reader Ted F. also called out policymakers for recent failures, asking: “Does anybody in any of the central banks have a clue as to what is going on? Have the central banks so over-managed the world’s economy that they have killed it? It doesn’t seem to be responding to life support.”
Reader Michael S. added that the markets look extremely vulnerable, saying: “The Dow, S&P, and Nasdaq have a long way to plummet. The true infirmities will come home to roost. There is no avoiding it. What are they?
“Huge national debt … bad corporate debt … huge consumer debt … including student debt … a corrupt Congress … and a passive, iPhone toting public. The termites have eaten out the interior. A thin facade remains, but not for long.”
On the other hand, Reader Robert P. sounded a somewhat more optimistic note. His take:
“The fact is that the old saying ‘Don’t fight the Fed’ still applies, and even with the recent 0.25-point hike, the Fed promises to continue to be extremely easy with monetary policy and has taken great pains to make that message clear. Bottom line, that equals more gains in the stock market regardless of who’s president.”
Thanks for taking some time to sound off. Trading may be a bit volatile and thin during the next two holiday-influenced weeks. But the stock market looks like it’s facing some major longer-term challenges to me. That means 2016 may get off to a rocky start. If you agree or disagree, share your comments and rationale below.
Brent crude, the global oil price benchmark, fell to around $36-a-barrel in London this morning. That puts crude at its cheapest price since the summer of 2004, though analysts at Goldman Sachs say oil could drop as low as $20 in the weeks ahead.
China’s National Chemical Corp. is reportedly trying to buy Syngenta AG (SYT) in the largest Chinese acquisition to date. It is reportedly willing to pay as much as $44 billion for the Swiss chemical company.
The head of the global soccer organization FIFA, and the president of Europe’s UEFA soccer organization, were banned from overseeing the sport for eight years. Sepp Blatter and Michel Platini were accused of ethics violations and financial shenanigans.
The reports are in, and Walt Disney’s (DIS) Star Wars: The Force Awakens movie took in more than half a billion dollars in ticket sales in its opening weekend. That includes $238 million in gross sales in the U.S. and another $279 million overseas. Personally, I saw the movie with my daughters over the weekend and definitely came away impressed.
Any thoughts on the ongoing struggles in the energy markets? What about China’s latest foray into the M&A arena? Do you believe FIFA needs to clean house? And if you saw the latest Star Wars movie, what did you think about it? Share your thoughts on those or other topics here at the website.
Until next time,
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