For months it’s been all about 3%. Investment analysts, traders, managers and commentators all agreed: if the ten-year US Treasury bond hits 3%, something is going to snap.
Well, according to Bloomberg radio, yesterday was the big day. For the first time since the very beginning of 2014, the yield rose above the 3% mark. And on cue, US stocks tumbled. It was their fifth straight losing day.
Why? What’s so magical about that particular level? Depends who you ask.
First, there’s technical analysis. Chartists watch symbolic numbers on charts based on trend lines, moving averages and much much more. 3% is supposedly a crucially important level. 3.05% was last seen in 2011, so that’s the next milestone.
Breaching these lines in the sand suggests that the decades-long downtrend in interest rates could be ending. To be clear, it suggests a higher probability that the downtrend has ended than if the yield had turned back down without breaching the level. Technical analysis is all about getting an edge it terms of probability, not about finding a false sense of certainty.
Next up are the equity analysts. A 3% yield is enticing to the income investors who have been buying dividend stocks while grumbling about low interest rates. As expected, dividend stocks were pummelled yesterday as investors rotated out of stocks and into debt. Hence the ten-year yield quickly fell back below 3% again as investors bought bonds.
Bond experts see the 3% level as the point at which debt starts becoming unaffordable. How many mortgage payers, zombie firms and governments around the world can afford to refinance government debt at higher rates? Remember, the ten-year yield is a reference rate for a huge list of other interest-bearing securities.
With debt to GDP levels above 100% for governments around the world, and US interest rates at 3%, you need a lot of GDP growth to stop your interest bill from growing faster than your economy.
For me, the real worry is a little different. Rising rates suggest we are late in the cycle of boom and bust. Remember, each downturn is preceded by tightening monetary policy. And each time, they’ve only managed to tighten less than the previous cycle. Which also means they can cut less when the downturn comes.
But there’s something uncomfortable about allusions to what usually happens. 2013 and 2014 saw the taper tantrum strike markets. And it suggests something unfamiliar about cycles.
The taper tantrum remembered
Back in 2013, the Federal Reserve announced it would slow down its quantitative easing (QE) policies. The market wasn’t ready for the minor change. A long list of investments that are not supposed to be correlated all fell simultaneously.
What actually happened still isn’t clear. The change to the Fed’s policies was enough to cause chaos. Why did the announced adjustment wreak such havoc?
Some say it’s because the change was unexpected. That’s why central bankers are now so careful to announce policy years in advance. Japan’s central bank recently announced its plan to return to 2% inflation sometime in the next five years. Perhaps it’s planning to hire Arsene Wenger to achieve this within the timeframe.
But perhaps central bankers are completely underestimating how reliant the market is on them. The price of assets is set by the marginal buyers and sellers. If the central bank is active at this margin, then stepping out of the market is a huge change. Where does the market ratchet down to?
Can something snap?
What did we actually learn in 2014? That higher rates and less central bank action are dangerous? Or that this risk is rather easy to resolve? You just lower rates back down again and return to QE.
This strikes at the heart of the biggest question in the market right now. What problems can’t money printing solve in the short term?
If a spiking ten-year yield is the problem, central banks can just push the yield back down again. It’s just a question of how much money it takes. And central bankers are hardly shy about adding zeros.
Perhaps this is how Akhil Patel’s predictions will play out. In Cycles, Trends and Forecasts, he’s predicting another boom. At worst, there’ll be a mid-cycle slowdown.
You can find out how to position yourself for the coming boom here. And if I’m right that central bankers can paper over any problems, then I agree with Akhil about what’s coming next.
But for one small detail. Which you’ll discover in your inbox soon.
Back to today’s topic…
The amusing trade-off between monetary policy and debt in this cycle is the lack of a true recovery to begin with. Fiscal positions around the world haven’t exactly recovered. The US deficit is vast and growing. The UK and Germany are among the most prudent, but hardly doing well.
Where is the recovery? And what happens if we don’t really get one?
If monetary policy hikes rates when debt to GDP levels are high, it hikes the interest bill too. How can government budgets recover when growth comes with higher interest bills?
They can’t. Trouble is baked in.
Until next time,
Nick Hubble
Capital & Conflict
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Category: Economics