Just recently, I was accused of “quietly abandoning” my belief that rates are ultimately headed toward zero. Nothing could be further from the case particularly as the recent rise in rates is accelerating my base case.
The chart below, which tracks rates back to the late-1800’s shows, that rates can, and do, remain low for extremely long periods of time.
Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter.
What is clear is that the rise in rates in the 60-70’s was combined with rising inflationary pressures driven by rising wages and ultimately economic growth. It was also a time where very low indebtedness allowed rates to rise without a severely negative consequences.
With households, corporations, the government and investors more levered today than ever before in history, the rise in rates is the “fuse” that will eventually ignite the next major reversion. As I discussed yesterday, that epicenter of that reversion will be pension funds.
When the $4-5 Trillion in required bailouts for pension funds begin, not to mention potential bailouts of mortgages, auto loans, and student loan debt, the demand for Treasuries will surge sharply driving rates lower once again. The next rounds of Quantitative Easing will dwarf what we have witnessed over the last decade.
What is clear is that sharp increase in interest rates, particularly on a heavily levered economy, has repeatedly led to negative outcomes. With rates now at extensions only seen in 7-periods previously, there is little room left for rate acceleration before such an outcome spawns.
Given that such negative outcomes have always led to lower future rates, this time is unlikely to be any different. The only question is the timing, and as they say, “timing is everything.”
But don’t dismiss my recent quietness on rates as a change of attitude, actually we remain heavy buyers of bonds every time rates hit overbought levels.
However, while I am fairly certain the “facts” will play out as they have historically, rest assured that if the “facts” do indeed change, I will gladly change my view.
Currently, there is NO evidence that a change of facts has occurred.
Just something to think about as you catch up on your weekend reading list.
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