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Why will interest rates go up?


stahleyp
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Almost all advisors (with the exception of Hoisington) suggest clients should mostly invested in short term bonds.

 

Almost everyone "knows" or thinks interest rates will go up.

 

Up until a couple years ago, people thought it would be soon. Besides the fact that they were higher than before, why does that have to mean they'll be higher now?

 

A couple reasons why I think interest rates may stay lower much longer than people expect (have have already).

 

rates are low across the world. Which country will want to be the first to raise? (I think Buffett alluded to this a little while ago).

 

The second reason is affordability. If the US raises rates too much, it would have a pretty big impact on the budget. State, many already in financial binds, wouldn't be able to refinance at low rates, too.

 

So why are people so certain that they'll be higher or normalized over the next several years?

 

I don't have a strong opinion on interest rates but just want to better understand both sides.

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I'd rather not get into macro topics, there are bunch of macro warriors who can answer you, but here it goes:

 

Rates go up if we have inflation. Inflation goes up if we have wage inflation and possibly monetary expansion. If we get protectionism, full employment and infrastructure spending (or some subset of the above), we might finally get wage inflation. So.

 

I'm not predicting rate direction, just explaining possible course.

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I think if you are investing in long bonds here, you are fooling yourself - you are speculating. The potential return is not commensurate with the risk. That's not a view that interest rates WILL rise, that's just basic math.  IMO, best to stay short duration on bonds and take equity risk that offers a more attractive risk/return profile.

 

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Almost all advisors (with the exception of Hoisington) suggest clients should mostly invested in short term bonds.

 

Almost everyone "knows" or thinks interest rates will go up.

 

Up until a couple years ago, people thought it would be soon. Besides the fact that they were higher than before, why does that have to mean they'll be higher now?

 

A couple reasons why I think interest rates may stay lower much longer than people expect (have have already).

 

rates are low across the world. Which country will want to be the first to raise? (I think Buffett alluded to this a little while ago).

 

The second reason is affordability. If the US raises rates too much, it would have a pretty big impact on the budget. State, many already in financial binds, wouldn't be able to refinance at low rates, too.

 

So why are people so certain that they'll be higher or normalized over the next several years?

 

I don't have a strong opinion on interest rates but just want to better understand both sides.

 

I generally agree - I don't quite know if the long-term bond rally is over:

 

1) I'm a natural contrarian and long-term Treasury shorts/underweights are at extreme levels

2) I don't buy the super-awesome-Trump-everything-is-ok rally which took rates 100+ bps off their lows

3) Pensions' underfunded status ensures that there will be a bid for duration every time rates back up 50-100 bps

4) Demographics, demographics, demographics

5) Relative value - even after currency hedging, the long-end has offered international investors a yield pick-up over their domestic bonds which has driven demand from Europe and Japan for U.S. Treasuries.

 

I don't know if rates will break their prior lows (though I think it's a near certainty in a recessionary scenario), but I do believe the long-end of the curve will remain relatively well bid, even if front-end rates rise, unless if there is an absolute explosion in inflation.

 

Disclosure: Long zero-coupon, 25+ year bonds via an ETF.

 

 

 

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There is too much debt in the world for rates to go up much. 

 

Except...inflation might be self-reinforcing.  If it accelerates, and people start to spend cash because cash is losing value, then the velocity of money rises and inflation accelerates more.

 

If that gets bad, then Central Banks have to decide whether to stick to their inflation targets, raise rates, and trigger a recession; or to let inflation go for a while.

 

Long bonds, though, are a speculative macro bet at this point.  There is no value in them.  Prefs are more interesting - good writeup of their valuation vs long term averages on Philosophical Economics recently - but you still get hammered if there is inflation.  Unless, of course, you're in a Canadian rate reset preferred trading below par.  The probable real returns on some of those look very decent.  (I'm long Atlantic Power and Aimia.)

 

Of course, we are ignoring the fact that huge inflation has already taken place, just not in CPI.  Houses, bonds, stocks.  In other words the cost to purchase your shelter and your retirement have spiralled massively, and yet Central Banks are still able to claim there's been no inflation.  Crazy.

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What I find very interesting is the abrupt change that has happened since the Trump election. The market is no longer focussed solely on the US Fed. This is a very good development. Interest rates need to normalize and it looks like this is now finally happening.

 

Where we go is anyone's guess. Personally I find Jeff Gundlach at Doubleline and his monthly podcasts required listening to help understand where interest rates might be going. I think his current forecast is for yields on the 10 year US bond to move higher later this year (to the 2.6% range and possibly as high as 3%). Looking out a few years he would not be surprised to see yields move to 4 to 6%.

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Almost all advisors (with the exception of Hoisington) suggest clients should mostly invested in short term bonds.

 

Almost everyone "knows" or thinks interest rates will go up.

 

Up until a couple years ago, people thought it would be soon. Besides the fact that they were higher than before, why does that have to mean they'll be higher now?

 

A couple reasons why I think interest rates may stay lower much longer than people expect (have have already).

 

rates are low across the world. Which country will want to be the first to raise? (I think Buffett alluded to this a little while ago).

 

The second reason is affordability. If the US raises rates too much, it would have a pretty big impact on the budget. State, many already in financial binds, wouldn't be able to refinance at low rates, too.

 

So why are people so certain that they'll be higher or normalized over the next several years?

 

I don't have a strong opinion on interest rates but just want to better understand both sides.

 

Your question seems to imply that central banks control rates, or is at least a central bank-focused view.  They are a factor but I think market forces are a greater influence. As TwoCitiesCapital noted, there's an endless bid for duration, demographic demands for income assets, and relative value reasons for capital to be in US bonds.  Bottom line is that there is too much capital chasing safe assets, and until that changes rates will stay near historic lows.

 

The biggest near term factor might be a change in perception of the US as the safest, most stable place to invest capital.  Not sure how to model that though.

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  • 6 months later...

Looking forward moving to a normalized stock picking mode.

Disclosure:

-have held TLT (ETF 20yr+ long term US government bonds) since 2010, with opportunistic buying along the way.

-net seller overall, especially in the last 2 years, with a residual +/- 10% of portfolio.

 

Reasons to keep residual position:

-USA potential as safe haven

-Deleveraging environment with extreme over-indebtedness

 

But now:

-The Fed intends on tightening.

-The US may lose its cleanest dirty shirt status.

-This is a bubble and, at some point, the cycle will turn.

For some horizon:  https://seekingalpha.com/article/4121565-800-years-bond-markets-cycles

 

According to the economist Eugen von Böhm-Bawerk: “the cultural level of a nation is mirrored by its interest rate: the higher a people’s intelligence and moral strength, the lower the rate of interest”. ???

 

Looking for contrarian opinions. In the meantime, will read more about the Venetians.

 

 

 

 

 

 

 

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