Not So Fast!
By: Tony Minopoli
In a previous blog post, I raised the question, “How high can rates go?”. Specifically, I was discussing the rate on the 10-year Treasury. We ultimately saw a closing high of 4.99%1. As I pen this on November 30th, the 10-year Treasury yield stands at 4.33%, representing a decline of 66 basis points in fairly short order. It has been a quick move which is having many consider if we have seen the high and if should we now begin focusing on how low can rates go.
All of this got me to reflect on the rate environment and I want to offer some thoughts. I have written about the budget deficit of $1.7 trillion that the U.S. had for the last fiscal year. There does not seem to be the political will to actually do anything to rein in spending, so this creates an upward bias on rates because borrowing costs and government spending remain high.
But not so fast. There are certainly cracks appearing in the employment market and this is being met by some weakness in spending. I was speaking with an economist who said his initial read of the early Christmas shopping is not showing any level of robust growth. I have also been reading about some “you only live once” spending as well as spending that is occurring because of the general anxiety people have with respect to economic conditions. The thinking is that if things are going to get worse and you have money, you might as well enjoy the “present.” These are people who subscribe to the Nero school of thought that if Rome is burning, you might as well play your fiddle.
If spending is slowing and the economy slows as a result, this argues that interest rates would likely come down so you should be long bonds to take advantage of declining rates, but again, not so fast. While we are seeing this slowing, the Fed has not declared victory on inflation. We are also coming into an election year so I have been weighing which pillar the Fed will focus on protecting the most. For the last eighteen months, the Fed has fought to protect the inflation pillar and has actively driven rates higher to combat inflation. Once this started to create a banking crisis, the Fed slowed down and did not completely put out the inflation fire. So, the continued threat of inflation and its harm to the economy, could ultimately hurt the Fed’s twin pillar of responsibility: unemployment.
As we are entering an election year, we are starting to think that the Fed might focus on keeping employment in better shape and this might keep the Fed from raising rates, and they might even cut rates in the first part of the year to bolster the economy if unemployment rises. One more time, not so fast. We are not forecasting a soft landing. The tug of war from the Fed likely keeps the 10-year in a range of 3.5% to 4.0% because there is still some inflationary pressure. The question we are still trying to answer is the depth and the severity of any recession we may enter. More to come, but just some thoughts on the last day of November.