Interest Rate Turn?

Interest rates have bottomed and will rise substantially during the next decade.

OR:

Interest rates CAN’T rise because rising rates will crash governments, economies, derivatives, equity markets and more.

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Consider the chart below for the monthly 10 year T-Note Index of Interest Rates.

c-10-year-rates

Date                         Rate             Rate

Jan. 2000                  6.82%                       High

Nov. 2001                                    4.09%     Low

Apr. 2002                  5.46%                        High

June 2003                                   3.07%      Low

June 2007                 5.32%                        High

Dec. 2008                                    2.04%      Low

Apr. 2010                  4.01%                         High

July 2012                                     1.39%       Low

Dec. 2013                  3.04%                         High

July 2015                                     1.33%        Low

Average drop in interest rates was about 2.5%.

The Bigger Picture:

a-interest-rates-200-years

Interest rates bottomed in 1946, topped in 1981, and bottomed (probably) in 2016. Rates rose for 35 years and fell for 35 years.

Can interest rates go lower? Ask the machines, central banks and algos that control them.

But given the rapid rise since August 2016 it seems increasingly likely that rates will continue to rise from what looks like a generational bottom. They might rise for several decades.

What is a reasonable target?

 

  1. Current 10 year rates are about 2.4% and have reached a two decade declining trend line.
  2. A break into the 2.5% to 3.0% range would indicate higher rates coming.
  3. A significant break above 3.0% would strongly indicate that rates hit a generational bottom in 2016 and will rise much higher.
  4. Average drop from high to low since 1999 has been about 2.5%. If we apply that to guess the next short-term peak, then 1.33% plus 2.5% is about 4%.

Could rates rise to 4% on the 10 year note? Consider the following unlikely events for comparison.

  • The NY Times gave HRC an 84% chance of winning five days before the election, yet she lost.
  • The Brits voted for exit against all odds and polls.
  • Silver dropped from nearly $50 in 2011 to under $14 in 2015.
  • Amazon stock rose from under $10 in 2001 to over $800 in 2016.

A 4% rate seems likely by comparison. Average rate for 200 years has been over 5%.

CONSIDER:

 

  • My expectation is that interest rates have bottomed and will rise for years.
  • They could easily rise to 4% or considerably higher. Is 7% unlikely when the 200 year average is more than 5%?
  • Higher interest rates will hurt prices for real estate and stocks.
  • What about auto loans, student loans, credit card interest charges, massive corporate debts, real estate financing, sovereign debt service, and the coming recession/depression?
  • Derivatives? Over $500 trillion of derivatives are tied to interest rates… This could be rather difficult …

From John Rubino: The Variable-Rate World Stares Into the Abyss – Again

“… a picture emerges of a system that can’t handle rising interest rates, but is nonetheless getting them. The result? At best a global slowdown and at worst an epic crisis.”

From Daniel R. Amerman, CFA: The Imminent Multi-Trillion Dollar Surge in Social Security and Medicare Costs

“For decades we have known that the time would come when Social Security & Medicare costs would begin a rapid and explosive growth upwards. That time is no longer the distant future – but something that will take place next year, and the year after, and the year after.”

CONCLUSIONS:

 

  • If interest rates have bottomed they are likely to rise for many years. This will place considerable pressure on leveraged assets and the multiple $ trillions in dodgy and leveraged investments and shaky loans that might not survive rising interest rates.
  • Expect the Fed (and other central banks) to “do something” to “help” with $1 – $2 trillion deficits and rising rates. Expect “printing” dollars, massive bond monetization, “helicopter money,” more QE and other “unconventional” measures. Hyperinflation is possible in the U.S and elsewhere. Watch Japan and Europe.
  • Expect the Fed to rescue, as best they can, the financial and political elite. Tough luck for everyone else…
  • Bonds and stocks are vulnerable and could decline from nosebleed levels. Most other “assets” have counter-party risk – I’m not paying you because I didn’t get paid. Gold and silver should come to mind.
  • Gold and silver do not have counter-party risk.
  • Gold and silver have several thousand years of history indicating they are a store of value. Can anyone say the same for the euro or the U.S. dollar?
  • Looking forward to a traumatic 2017 and 2018….

Gary Christenson

The Deviant Investor

6 thoughts on “Interest Rate Turn?

  1. Dear Gary,

    Thank you for your analysis, thoughtful and well-informed as always. Indeed it is possible that we have seen the lows in interest rates, and that they will move higher over the years ahead. I have seen arguments elsewhere that interest rates “can’t” go higher because of the staggering magnitude of the outstanding debts that have to be serviced. It is not possible for me to know which of these scenarios (higher rates or holding around some lower level) will turn out to be true. In such situations both sides of the argument have some pluses and minuses, and I am not astute enough to decide between them.

    But as Warren Buffett often says, why try to take on difficult challenges when solving easier ones easily can prove more profitable?

    Many reading this column are worried about the “problem” of falling precious metals prices. To me, falling prices of gold, silver, and their miners are not problems at all, but rather opportunities. I have been a steady buyer of gold since it broke below $1300 per ounce, and will scale up purchase sizes as prices scale down. I am following the same strategy with silver. When compared to standard corporate stocks that are trading at wildly high multiples of dodgy earnings, the choice is not difficult.

    Precious metals prices will bottom, and that bottom comes closer with each downtick. It is all but impossible (at least for me) to recognize the absolute lows except in a rearview mirror, but I hope that at least some of my purchases will bracket the nadir.

    For the record, I bought my first gold at $35 on August 15, 1971, and kept buying steadily through th next several years as prices rose through $42 per ounce. Those positions were closed out before the end of the decade at 10X to 15X profits. To invoke my favorite philosopher, Yogi Berra, this time, too, it could be “Deja vu all over again.”

    Robert B. Eckhardt
    12.22.2016


  2. Everyone knows the story line of “Gone With The Wind”. What most people don’t notice and thus don’t remember – because it gets mentioned in passing – is how Captain Butler managed to have an opulent, lavishly-furnished mansion in Atlanta almost immediately after the start of Reconstruction. As he and his Boyz were handily running the Union blockade, Captain Rhett’s hand was out for payment in ….. ( wait for it ! ) …… GOLD. Yes sir, that evil yellow metal. No Confederate Currency for him, no sir. And where did he stash that gold ? Safely out of the way in England. And when the dust had settled and most of the rest of the devastated South was chowing down on poke salad three times a day, ‘ole Rhett was living La Dolce Vita.


  3. I believe you are alittle opimistic, Gary [i bet you don’t hear that very much!]……the EU will split up, the southern periphery will default on 3TRIL$, that takes out the european banks, and by connection the US’s…….Japan will be toast at their debt/GDP, owed to their own people.

    While they will print money like never before, they will not control rates due to overwhelming size of the public market, and that market will be debt averse to the extreme.

    at 7% the US will be in big trouble financing 20TRIL$…..close to all taxes used just for interest?…….what cannot be repaid by anyone unable to print [states and their pensions, etc., etc.]….will not be repaid……..debt will no longer be simply ‘money’.

    But yes, the great reset is almost here….while it will not be fun for anyone, the properly positioned will at least come out financially good……but what a terrible sight it will be to witness, and many friends n family that won’t listen are going to be devastated………we might be feeding them.

    Excuse me, i have to go get a drink…..Jesus……


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