As I write this, the markets are still near all-time highs and long-term Treasury rates sit at just under 3%.
Because the Fed seems to have met its dual mandate from Congress (full employment and low inflation), the Fed is expected to hike rates another two or three times this year.
And with that, it seems like all is well with our economy chugging along at 2% (even though first quarter GDP is estimated at 0.9%), inflation has hit the Fed’s target at 2%, unemployment is low, and wages are rising. But really, is everything all that great?
I put together my list of potential pitfalls for the markets, especially the interest-rate markets. This list is by no means everything (anyone claiming to have a crystal ball is trying to sell you something), but in my estimation, it does contain the crucial ones.
Let’s start with an easy one: bad news. Despite a never-ending stream of venomous commentary and ominous reporting, bad news hasn’t put much downward pressure on the markets. Despite taking a big loss on healthcare reform, Trump has rolled back enough regulation and pushed hard enough for tax reform to keep the markets happy. Defeat or setbacks in Trumps’ fiscal or tax agenda could reverse the trend though.
Even if Trump does get his fiscal agenda through, the Congressional Budget Office (CBO) has a dire warning about our government debt and deficits (and really, if you’re been paying attention, these warnings should not be surprising). If spending isn’t reigned in substantially, the CBO estimates show debt-to-GDP will rise to 150% in 2047 and our deficit would increase to just under 10%. Entitlements and rising interest rates are the big factors in their calculations. The CBO isn’t predicting when there will be a fiscal crisis, but odds are rising without any sort of a fix.
But forget the CBO estimates 30 years down the road – the White House and Congress need to get a budget or continuing resolution passed or we’ll see a government shutdown by the end of this month! Trump wants an increase in military spending while cutting social programs and funding his border wall… good luck with that!
Let’s talk interest rates, my bread and butter. The Fed-fueled stimulus packages and abnormally low interest rates of the last eight years have been good to real estate. Home prices have exceeded those before the last bubble popped in 2007, so I have to ask, are we in another housing bubble? Boston Fed President Eric Rosengren said in a speech last month that another housing collapse could have a major impact on financial stability. He isn’t predicting that it will happen, but low interest rates and rising property values are a concern because rising rates and falling values could cause major financial stress throughout the banking system, not to mention another hit on leveraged real estate owners. Was that the Fed admitting a policy mistake? See what Harry had to say about this earlier this week in Economy & Markets.
Low interest rates have also been kind to the auto industry. Subprime and ordinary loans are reaching levels of delinquency not seen since 2009. Auto sales reported this week were much lower than expected and used car prices are crashing. Another fiasco in the cards?
Harry has written about the trillion-dollar student loan debt bubble that’s been percolating for years (see here and here, for instance). More than one in four loans are in default today and it was only one in nine just 10 years ago. Tuition is only going up, up, and up. How much longer can this trend go on?
The final bullet point on my list: global events. Last week, the UK triggered Article 50 to begin its exit from the European Union. So far, Brexit hasn’t been that big a deal for the markets, but again, negotiations are just starting and won’t conclude for another two years. How friendly (or not) the negotiations are might have an impact on the markets.
Elections in France could result in political turmoil if Marine Le Pen is elected. Her priorities include France’s national interests ahead of the European Union’s, and if election could spell a possible exit from the EU like that of the UK. Her election later this month could also have a major impact on the markets like Brexit and Trump’s election did.
Remember Greece? They were bailed out, and it’s nearing time to do so again. What will the EU do this time? Kick the can down the road, or take a default in the teeth?
China’s real-estate bubble and debt bubble haven’t been mentioned in a while. There’s the issue of their pesky, nuclear-enabled neighbor, North Korea. Trump met with China’s leader this week with many items on his agenda like currency manipulation, trade inequality, and North Korea’s increasing nuclear threat.
Russia’s meddling throughout the world has irked the U.S. for years. Putin’s backing of Syria’s regime is another sticking point on the U.S. war on terror. Will Trump get tougher or will Putin push even harder?
The above list isn’t exhaustive, but I keep it close because market volatility is often linked with these bullet points – and that’s good for Treasury Profits Accelerator readers! We make money when the Treasury bond markets overreact!
Editor, Treasury Profits Accelerator