As you know, I’ve been talking about a turn higher in long-term interest rates for going on two months now, while Harry has been talking about the “Fixed Income Trade of the Decade” since last November.
As rates have indeed moved higher, Treasury Profits Accelerator subscribers have been profiting nicely! Now, this might not be the trade of a decade but we are up well over triple digits (so far), ever since my system alerted us to a trend change in early September! Not to mention Boom & Bust readers who have seen a healthy 20% gain on a similar trade.
Right after Trump was declared the winner, Harry warned that rising interest rates are signaling that central bank policies of QE and negative rates are failing. He went on to say that 10-year Treasury bond rates could spike as high as 3.1% in early 2017 (rates that already surpassed his near-term target of 2.25%).
Trouble abroad, trouble at home
With all the international risks to the markets such as the German and Italian banking crisis, Brexit, and the Chinese real estate bubble still front and center, a spike in interest rates could spell disaster for stocks right here at home.
When rates rise it’s more costly for companies to borrow and for customers to finance purchases. You might’ve heard my colleague John Del Vecchio bang the drum in Forensic Investor over companies borrowing cheap money so they can buy back their own stock to keep stock values high even if revenues aren’t. When consumers have to pay more to finance purchases, sales will suffer. Corporate valuations are already high based on earnings so it won’t take much of a rise in interest rates to tip the scales (and Rodney talked about this in the November Insight Video).
Central banks around the world are beginning to reconsider expanding their stimulus programs and may need to start tapering. The Fed promised early in 2016 that there could be possibly four rate hikes this year, but haven’t pulled the trigger on even one hike yet.
But with the way rates are moving, the Fed may be backed into a corner and have no choice but to raise rates next month. The market has already priced in a near-certain rate hike.
The Fed’s dual mandate from Congress – to promote employment and price stability – shouldn’t be a big concern for now. Jobs and wages have crept higher over the last year. Even as job growth has slowed, wages have continued to move steadily higher. The Fed is closing in on its inflation target of 2%.
Of course, the risks I mentioned earlier still remain and if rates were to tick higher yet, that could trigger a stock sell-off. And if that happens, the Fed will likely be off the hook to raise rates. In fact, they could be tempted to ease the quarter point they hiked last December.
What comes next
First things first, though. Between now and December 14, there are only a few data points the Fed will be scrutinizing in making their decision.
October new home sales are important because of the ripple effect new home sales create on the economy. Not only are real estate, mortgages, and construction affected by sales (or lack thereof), but new home sales flow to appliance sales, furniture sales, landscaping and other home items.
Keep in mind that rates didn’t really take a jump until the last week of the new home sales report so we won’t see the effect of higher rates until the November report is released in January. If sales slow, we could see a much bigger slowdown in January.
The Fed’s main inflation gauge is the Bureau of Economic Analysis’ Core PCE Price Index that will be out with the October Personal Income and Outlays report. The September Price Index hit 1.7% but has been climbing with rising wages. If we see a tick higher in this report, there will be no excuse from the Fed not to hike.
And unless there’s a big miss in the November Employment report, the Fed will have no choice but to hike rates. The unemployment rate has been at or below 5% for a year. Wages have been on the rise for several months. Sure, quality of jobs is a big question mark but rising wages signal improvement here.
Finally, November retail sales will be reported on decision day for the Fed. November’s report is more important than most since it includes the start of holiday buying and will signal how profitable retailers may or may not be for the year.
So, if one of the many market risks don’t trigger a stock market sell-off before the next Fed meeting, there are only a few excuses the Fed can make to not hike interest rates. If the Fed hikes rates, that could prompt other central bankers to start to taper their stimulus programs.
Remember the sell-off in U.S. stocks after the Fed announced their plans to taper QE? The S&P 500 lost about 10% in a month!
Remember what happened after the Fed hiked last December? The S&P 500 lost nearly 12% in a little more than a month!
We’re now near record highs in the S&P 500, again. The Fed is ready to hike again so what might happen this time?
Be ready for what the Fed is about to do and look out for Harry’s “Fixed Income Trade of the Decade,” it could be right around the corner.
Whatever the Fed may or may not do, it doesn’t really matter. Overreaction to volatility in long-term treasury bonds is another way Treasury Profits Accelerator subscribers profit.