Interest Rates on the Move! (Finally)

[audreyh1]

The national debt is $20 trillion and increasing by $1 trillion per year. Look at the cost of servicing this debt:

https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

Do you really think that the Federal Reserve are going raise rates that much? Think of what it will do to the cost of servicing that debt. The spike in the 2 - 10 year notes has more to do with supply coming to the market due to the increase in the budget deficit. Then there all those S&P 500 companies that issued debt to buy back their stock over the past 7 years. They will get crushed. The real estate market will also get crushed. I would like nothing more to hold a portfolio of FDIC insured CDs that yield 5-7%, but I just don't see that happening.

The Federal Reserve does not set long-term interest rates. They can often influence them, but they are essentially out of the Fed’s control.

 

[copyright1997reloaded]

The national debt is $20 trillion and increasing by $1 trillion per year. Look at the cost of servicing this debt:

https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

Do you really think that the Federal Reserve are going raise rates that much? Think of what it will do to the cost of servicing that debt. The spike in the 2 - 10 year notes has more to do with supply coming to the market due to the increase in the budget deficit. Then there all those S&P 500 companies that issued debt to buy back their stock over the past 7 years. They will get crushed. The real estate market will also get crushed. I would like nothing more to hold a portfolio of FDIC insured CDs that yield 5-7%, but I just don't see that happening.

I'm still trying to get my head around your argument here. If there is more demand for something (debt), it should result in a higher price (interest rate) Yet you seem to suggest that the Federal Reserve controls the 2 year and 10 year (and CD rates). They do not have direct control on these. They can change the reserve requirement (the sledge hammer), can change the discount rate, and can do open market operations.

Yes, the government has incentive to try to keep the long end of the curve from exploding and thus exploding the debt servicing costs. However, I'm not seeing their ability to do so assuming the overall demand for credit keeps expanding.

 

[adrift]

Then there all those S&P 500 companies that issued debt to buy back their stock over the past 7 years. They will get crushed.

I don't understand this. Companies issued debt at historically low interest rates. Now, those rates seem to finally be going up, how will they get crushed? This is a sincere question. What's the risk here?

 

[audreyh1]

I don't understand this. Companies issued debt at historically low interest rates. Now, those rates seem to finally be going up, how will they get crushed? This is a sincere question. What's the risk here?

It’s only a problem if they need to refinance that debt, if, for example, they don’t have the ready funds to pay back the principal when due.

Many companies issued debt so they could leave their foreign profits overseas and enjoy the super low interest rates. Now many have repatriated these foreign held funds since the tax cut bill was passed. So many probably do have ready funds to pay back the loans, but won’t do so until they have to and will enjoy the cheap credit in the meantime. Otherwise their cash flow could probably cover it. So many companies are sitting on mountains of cash - way more flush with cash now compared to 2008 when many companies relied on the short-term credit markets (money markets) to finance their payroll and got a nasty surprise.

But not all of them. Some definitely will be hurt by rising interest rates.

 

[Freedom56]

I'm still trying to get my head around your argument here. If there is more demand for something (debt), it should result in a higher price (interest rate) Yet you seem to suggest that the Federal Reserve controls the 2 year and 10 year (and CD rates). They do not have direct control on these. They can change the reserve requirement (the sledge hammer), can change the discount rate, and can do open market operations.

Yes, the government has incentive to try to keep the long end of the curve from exploding and thus exploding the debt servicing costs. However, I'm not seeing their ability to do so assuming the overall demand for credit keeps expanding.

Wrong! If there is more demand than supply for debt (I am referring to notes and bonds), prices go up and yields go down. The Fed controls the fed funds rate and discount rate that impact short term borrowing and savings rates banks will pass onto businesses and consumers and ripple through the yield curve. What I was saying is that when bond funds are forced into liquidating their holdings to raise cash, it can create a supply/demand imbalance causing a bond or note price to fall bringing the yield up which can create buying opportunities. Markets move in anticipation of economic activity. The narrow spread between the 10 year note and 30 year bond signaling caution ahead.

https://ycharts.com/indicators/30_year_treasury_rate_less_10_year_treasury_rate

Look where it was in 2013, the last time the so called experts predicted rising rates, and look at it now. This is telling me that the market does not buy the rosey economic forecast.

See below from Barron's

https://www.barrons.com/articles/still-worrying-about-an-inverted-yield-curve-1517624774

 

[adrift]

It’s only a problem if they need to refinance that debt, if, for example, they don’t have the ready funds to pay back the principal when due.

Many companies issued debt so they could leave their foreign profits overseas and enjoy the super low interest rates. Now many have repatriated these foreign held funds since the tax cut bill was passed. So many probably do have ready funds to pay back the loans, but won’t do so until they have to and will enjoy the cheap credit in the meantime. Otherwise their cash flow could probably cover it. So many companies are sitting on mountains of cash - way more flush with cash now compared to 2008 when many companies relied on the short-term credit markets (money markets) to finance their payroll and got a nasty surprise.

But not all of them. Some definitely will be hurt by rising interest rates.

The recent tax law changes will certainly effect companies differently. Ironically, many of the biggest beneficiaries will take a short term accounting loss. I don't think any will repatriate money if it will cause them to be "crushed".

Unless an S&P 500 company is already deep in the weeds, I'm struggling to see how it couldn't issue additional debt in a higher interest rate environment to pay off historically low interest payments to avoid being "crushed".

 

[Freedom56]

It’s only a problem if they need to refinance that debt, if, for example, they don’t have the ready funds to pay back the principal when due.

Many companies issued debt so they could leave their foreign profits overseas and enjoy the super low interest rates. Now many have repatriated these foreign held funds since the tax cut bill was passed. So many probably do have ready funds to pay back the loans, but won’t do so until they have to and will enjoy the cheap credit in the meantime. Otherwise their cash flow could probably cover it. So many companies are sitting on mountains of cash - way more flush with cash now compared to 2008 when many companies relied on the short-term credit markets (money markets) to finance their payroll and got a nasty surprise.

But not all of them. Some definitely will be hurt by rising interest rates.

Not all companies are flush with cash or have stashes overseas. First we have GE playing the buyback game and is losing, Chevron and Exxon are even worse. They still can't pay their dividend without issuing debt or selling assets. IBM is another example of financial engineering gone wrong. Many other energy and retail companies are facing maturing debt with little cash.

 

[audreyh1]

Wrong! If there is more demand than supply for debt (I am referring to notes and bonds), prices go up and yields go down. The Fed controls the fed funds rate and discount rate that impact short term borrowing and savings rates banks will pass onto businesses and consumers and ripple through the yield curve. What I was saying is that when bond funds are forced into liquidating their holdings to raise cash, it can create a supply/demand imbalance causing a bond or note price to fall bringing the yield up which can create buying opportunities. Markets move in anticipation of economic activity. The narrow spread between the 10 year note and 30 year bond signaling caution ahead.

https://ycharts.com/indicators/30_year_treasury_rate_less_10_year_treasury_rate

Look where it was in 2013, the last time the so called experts predicted rising rates, and look at it now. This is telling me that the market does not buy the rosey economic forecast.

See below from Barron's

https://www.barrons.com/articles/still-worrying-about-an-inverted-yield-curve-1517624774

No. If the demand for credit increases, i.e. more people are seeking to borrow, interest rates will go up, not down. In this case, debtors are competing for loans, they will have to pay higher rates. Remember that these people/companies/govt are ISSUING debt/bonds, not buying bonds. More bonds issued - bond prices go down. Interest rates go up.

Up until January, inflation stayed stubbornly low, and interest rates as well. But that changed this year, big time. Interest rates have jumped sizeably, in short order. What happening? Well, economic growth/demand is increasing, inflation has finally reached the Fed target, the Fed is tightening - both with the Fed Funds rate and by unwinding the quantitative easing, more govt debt is being issued. The bond markets are responding to this. The yield curve has stopped flattening and is rising across the board instead - with the 5 to 10 year pushing up a little more strongly than the rest. A completely different picture from last year.

 

[audreyh1]

Unless an S&P 500 company is already deep in the weeds, I'm struggling to see how it couldn't issue additional debt in a higher interest rate environment to pay off historically low interest payments to avoid being "crushed".

Why would it pay off low interest debt? And even more why would it take on higher interest debt to pay off an already issued low interest corporate bond?

Seems like the companies would keep the low interest stuff as long as they could. Like consumers refinancing mortgages while rates are dropping, and then hanging on to the lowest rate loan for dear life.

I think it’s a problem for companies that don’t have the cash flow or large cash stash and thus are vulnerable to the rising rate environment. And of course there are some, as always. I suppose it’s a question of how prevalent this is.

 

[adrift]

Not all companies are flush with cash or have stashes overseas. First we have GE playing the buyback game and is losing, Chevron and Exxon are even worse. They still can't pay their dividend without issuing debt or selling assets. IBM is another example of financial engineering gone wrong. Many other energy and retail companies are facing maturing debt with little cash.

Are you shorting any of the stocks you mentioned? Are you shorting any other stocks?

 

[adrift]

Why would it pay off low interest debt? And even more why would it take on higher interest debt to pay off an already issued low interest corporate bond?

Seems like the companies would keep the low interest stuff as long as they could. Like consumers refinancing mortgages while rates are dropping, and then hanging on to the lowest rate loan for dear life.

Sorry. While I was responding to your post, it was mostly intended to be a comment about Freedom56's apocalyptic nonsense about the S&P being "crushed".

Obviously, I don't do forums well.

Peace.

 

[audreyh1]

Sorry. While I was responding to your post, it was mostly intended to be a comment about Freedom56's apocalyptic nonsense about the S&P being "crushed".

Obviously, I don't do forums well.

Peace.

No prob. Peace.

 

[Freedom56]

Are you shorting any of the stocks you mentioned? Are you shorting any other stocks?

No I'm not shorting any stocks. I don't own any stocks. I only invest in fixed income products. I research companies before investing in their debt. Read the preferred stock thread to see what I and others have been up to over the past two years. I made most of my money slowly through real estate and bond investing. I buy assets when they are undervalued and sell when I feel they are overvalued.

 

[HFWR]

I buy assets when they are undervalued and sell when I feel they are overvalued.

Why didn’t I think of that?

 

[Freedom56]

Why didn’t I think of that?

The typical passive bond or equity fund does the exact opposite. They are driven by fun flows. Ask yourself, how many funds shielded investors from the downturn in the markets in 2000 and then again in 2008?

How many people went out and bought homes and condos after 2009 that people and developers walked away from and banks were holding? There were many bargains in South Florida. Take a look at the price history of this new property:

DATE EVENT PRICE AGENTS
10/01/11 Sold $90,000-28.0%
04/17/11 Price change $125,000-28.6%
03/18/11 Price change $175,000-55.1%
10/16/07 Sold $389,900

Did you buy any at that time? We did? Most people would run scared.

 

[mcbraemer]

Ditto

My take on interest rates:

I sold all my perpetual preferred stocks and long duration notes off in December since they were trading at a high premium and the capital gain covers the next two years of dividend income from those securities for the next two years. I hold a lot of cash now and corporate notes with maturities from 2019 though 2028. I plan to hold those through maturity and they will provide my income stream. High investment grade notes (A and up) and bonds are grossly overpriced and have started to correct.


Agreed with your analysis (a lot), and ditto on the AA plan above - mine is very similar. I recognize a lot of signs from past down cycles today.

 

[audreyh1]

Big interest rate moves this week.

Over the prior two days there were big interest rate moves up in anticipation of the Fed Funds rate increase to 1.75%.

Frankly I was surprised that ramp up didn’t happen until the last minute.

And today big reversal as those rate increases are given back in a big one day drop down! And then some?

How can the 1 month T-bill be trading below the new Fed Funds rate?

 

[GravitySucks]

How can the 1 month T-bill be trading below the new Fed Funds rate?

Trade war fear causing an equity sell off and the need to park that money somewhere safe.

 

[Lsbcal]

The markets are constantly giving us lessons.

It seems stepping back a bit the intermediate term bonds have been pretty flat this last month. We seem to be still in positive returns on a 12 month basis (ignoring inflation). Here is a comparison of 3 funds for the last year:

VFIDX - intermediate term investment grade
VBTLX - total bond market
VFSUX - short term investment grade



Hopefully the increased yields will result in a somewhat better picture 1 year from now.

 

[audreyh1]

Trade war fear causing an equity sell off and the need to park that money somewhere safe.

Well that’s one pat explanation by the media - they just pull the reason du jour out of the air.

The trade stuff has been going on door q while, and the latest was announced yesterday of the day before, yet rates went up.

DOW down 700 suddenly - hmmm, something more is going on.

 

[audreyh1]

The markets are constantly giving us lessons.

It seems stepping back a bit the intermediate term bonds have been pretty flat this last month. We seem to be still in positive returns on a 12 month basis (ignoring inflation). Here is a comparison of 3 funds for the last year:

VFIDX - intermediate term investment grade
VBTLX - total bond market
VFSUX - short term investment grade



Hopefully the increased yields will result in a somewhat better picture 1 year from now.

Interest rates peaked in early February last year and then dropped through the summer before climbing again.

Now they are 0.6 to 0.4 % higher for the 10 year and 5 year compared to the Feb 2017 rates.

 

[Lsbcal]

Well that’s one pat explanation by the media - they just pull the reason du jour out of the air.

The trade stuff has been going on door q while, and the latest was announced yesterday of the day before, yet rates went up.

DOW down 700 suddenly - hmmm, something more is going on.

Bloomberg seems to equate the market decline with today's tariff announcement from Trump's administration.

I'm not sure markets need a complete set of reasons for going down at this stage of the business cycle. Some nasty declines way back in history have taken around 3 months to work their way towards a stable upward movement. But there aren't many data points in this observation so this is just my pet idea. If we took 3 months then this time it would be around early May before we get out of this downward churn.

 

[audreyh1]

Wow - huge retreat in interest rates over the past few days. 10 year trading where 5 year was, etc.

Quite a reversal.

 

[Freedom56]

My take on interest rates:

Short term rates will rise and the yield curve will continue to flatten and eventually invert signalling a recession. It's not a matter of if, but when. There is far too much debt out there for long term rates to move up meaningfully. Banks margins are being squeezed by a flattening yield curve and large defaults in commercial loans. The regional banks are will be impacted the most. It's a matter of time before banks start selling off. There are far too many stores, malls, and chain restaurants in this country. The retail sector is going to go through more pain than anticipated and as the year progresses will become more apparent. Remember, the market is driven by fund flows (supply and demand) in the near term and can behave very irrationally near market tops. This was the case in late 1999 and also 2007. Many sectors are already in a deep bear market - retail, REITS, energy, and some industrial stocks. If you hold individual bonds and notes to maturity, you can ride out this interest rate cycle. If you own bond funds, you are exposed to market risk and will suffer capital losses.

I sold all my perpetual preferred stocks and long duration notes off in December since they were trading at a high premium and the capital gain covers the next two years of dividend income from those securities for the next two years. I hold a lot of cash now and corporate notes with maturities from 2019 though 2028. I plan to hold those through maturity and they will provide my income stream. High investment grade notes (A and up) and bonds are grossly overpriced and have started to correct.

Any short term interest spike will cause a sell-off of bond and preferred stock funds into a fairly illiquid bond market which will cause some significant price swings in individual note and bond issues. That is the best time to buy notes, bonds and preferred stocks - when the passive funds are liquidating.

I stand by my forecast on interest rates from one month ago. The yield curve has flattened even more. Retail sales are weak. It's a matter of time before we see a rate inversion.

 

[REWahoo]

Freedom56, your interest rate/financial forecast is well-reasoned and entirely logical. Indications are it very well could be spot on and completely accurate.

I really dislike forecasts like yours because they tempt me to try to time the market, something I know (for me) is a losing proposition. So thanks for the heads up, but I'm not going to do anything more than watch, wait and rebalance when necessary.