Interest rate rising for ten years?

[thriftyandboringinohio]

Has the Fed decided to end ZIRP?
This article says Yellen has made that decision.

https://www.nytimes.com/2017/09/26/u...inflation.html


Around here I've been complaining about ZIRP for a long time, saying it's well past time to reverse course.
Like the legendary dog that finally caught a car, I'm not sure I know what to do if it really happens.

It's interesting to think about and explore.
One of EJ's central themes leading up to the financial crisis was interest rates.
Namely, how that long slow decline in interest rates from Volker to Bernake served to juice up the economy for so long in some important ways.

You can see it here in this chart from Forbes, declining interest rates starting in 1981.





Perhaps it's time to discuss some general trends and investment strategies for scenarios with the fed raising rates a point every year for 5 years or more.

Will it be the 1950's again?
Warren Buffet made his fortune in that environment, so there is money to be made in a raising rates environment.

[dcarrigg]

Re: Interest rate rising for ten years?

Has the Fed decided to end ZIRP?
This article says Yellen has made that decision.

https://www.nytimes.com/2017/09/26/u...inflation.html


Around here I've been complaining about ZIRP for a long time, saying it's well past time to reverse course.
Like the legendary dog that finally caught a car, I'm not sure I know what to do if it really happens.

It's interesting to think about and explore.
One of EJ's central themes leading up to the financial crisis was interest rates.
Namely, how that long slow decline in interest rates from Volker to Bernake served to juice up the economy for so long in some important ways.

You can see it here in this chart from Forbes, declining interest rates starting in 1981.





Perhaps it's time to discuss some general trends and investment strategies for scenarios with the fed raising rates a point every year for 5 years or more.

Will it be the 1950's again?
Warren Buffet made his fortune in that environment, so there is money to be made in a raising rates environment.

Broad thoughts about winners and losers:

Marginal Winners:
Bottom 90% of the under 40 crowd
State and muni budgets (pension funds)
Dividend/value stocks
Equity-financed ventures
Real production


Marginal Losers:
Bottom 90% of the over 40 crowd
Federal budget
Growth/overheated stocks
Debt-financed ventures
Finance and Real Estate
Old bonds

Decisive Winners:
Still top 10% of earners
Endowments and trusts that sense the wind-shift


Of course, lots could play into this. A commodity price spike timed with a rate hike might set off a wave of foreclosures in overheated markets again, especially if wages don't pick up and continue to grow. If you buy at the bottom of an upward rate swing, you're not going to have much home equity for a long time. So things like home repairs, additions, home depot stuff generally, pools, etc. probably will be bad bets. And you could end up underwater if property tax hikes plus rate hikes leave values depressed around you. Upside? As rates climb and property taxes climb, the principle declines. So more kids might be able to get into housing. Pension shortfalls won't be as wide every year, even if overall liabilities remain high. Saving accounts might come back on the margins if they start to pay out interest again and assuming credit card rates go up too. On the wealthy side, I think it's much more of a crapshoot. But the rules tend to be rigged so that even if you lose, you win.

And I still don't see us getting out of that time-frame without another recession. It would be unprecedented in US history. Plus nothing has changed since I wrote this post three years ago.

In fact, non-financial corporate debt just crossed the $6 trillion mark for the first time. It was only $5 trillion then. NASDAQ exceed the bubble top in Oct 2014. Up about 50% in just 3 years since. Median home price in NYC was $1.1M then. It's $1.4M now. Median income is $58k now. Was $52k then. So some positive motion. But still not enough to cover the housing price increase.

Meanwhile, housing is lumpy, but looking super-unaffordable again. Boston exceeded it's January 2005 bubble peak in real terms in August 2015, and has only continued to explode up from there. Housing prices are now in totally historically uncharted territory in real terms there. NYC is now up to Feb 2005 levels. Maybe a year out from bubble peak levels if it keeps going. San Francisco's bubble top was March 2006. They exceeded it in December 2015. They are now in totally uncharted territory too. Los Angeles today is up to December 2005 levels. They peaked at April 2006. If things keep going, they will be in uncharted territory by spring. Seattle surpassed their July 2007 bubble peak in May 2016. They are in uncharted territory. DC is at March 2005 levels, they peaked in March 2006. San Diego is at May 2005 levels. They peaked in March 2006. Denver escaped the last housing bubble, but now is about as bad as California. Miami's at May 2005 levels...we'll see what the Hurricane does there...ditto with Houston. But Dallas is way off in uncharted territory having escaped the bubble last time. Vegas and Phoenix and other hotspots from before actually aren't looking as bubbly now.

All that's just tinder, you know? People are flying high buying meals and gas and heat on credit cards paying $3,000 per month for a run down floor in a reconstruction-era triple decker with a subprime car loan and a pile of student debt. It won't take much of a layoff or squeezing of credit or hit to the monthly expenses from one direction or the other to create enough pressure for a spark.

It's only a paper moon. Especially the tech industry. More hocus pocus, PT barnum, useless replication, permanently unprofitable software platforms betting on a hail mary, Elon Musk promising the Moon and the Stars and delivering 220 cars in a quarter...half-unfinished magic gigafactories that are just assembling Japanese parts instead of making anything nursing state government debt-finance...What happens when the court wakes up and realizes the Emperor has no clothes?

For the bulk of what goes on, really, there are 4 numbers I sort of worry about on the grand scale for most people. Labor's share. GINI coefficient. Median income. Disposable income. Labor's share is still down. GINI is still up. Median income just finally hit 1999 levels (hurrah?), and GDP to disposable income hit its lowest level in US history in Q4 2012 / Q1 2013. It has bounced up to mid recession levels. But it still has not recovered.

I will say, at least the trajectory in two of the 4 indicators has been good for the last 4 or 5 years. But we're also near a market peak...or at least riding unprecedented highs in the stock market and real estate, etc. I fear unless we can get all 4 of those rowing in the same direction, or at least stop them from creating headwinds, we're bound to be blowing bubbles instead of creating lasting growth.

Rising interest rates may swap around the deck chairs on the titanic a little bit. And there's opportunity in change. But just look how much explosive growth in equities and other securities and assets is required to get even the most minor income trickle down to the masses. All the growth pressure in the world won't change the rate of that trickle unless we unkink the hose first. We can tinker with the water pressure. We can bang on the spigot. We can do all kinds of things. But if that damned hose is still kinked...

[jpatter666]

Re: Interest rate rising for ten years?

From your 2014 post....

"Imagine a 2016 [2017] where the NASDAQ is at 2000 dotcom-bubble-peak-high-levels nominally and the Case Schiller 20 is at 2006 housing-bubble-peak-high-levels nominally, but the labor participation rate is in the shitter and median income's down. How do you all think this will really end when some random panic du jour hits, as it does every 6-10 years or so?"

I think we're going to find out.

[thriftyandboringinohio]

Re: Interest rate rising for ten years?

... there are 4 numbers I sort of worry about on the grand scale for most people. Labor's share. GINI coefficient. Median income. Disposable income. Labor's share is still down. GINI is still up. Median income just finally hit 1999 levels (hurrah?), and GDP to disposable income hit its lowest level in US history in Q4 2012 / Q1 2013. It has bounced up to mid recession levels. But it still has not recovered....But if that damned hose is still kinked...

If we can get some wage inflation in real terms, that would turn around your indicators that all point to how well a working person is paid.
Which primes that demand pump you mention.

So instead of all boats rising on a tide of rising asset prices, we transition to a world where all boats rise on a tide of wages.
Speculative assets that require a greater fool will go cold. Real estate. Equities. Hedge funds. All in the dumper.
The old fashioned production and consumption economy comes back in style.

Sure, some speculators will lose their bets, effectively transferring wealth from trust-fund babies to lunch box Larry.
But Larry's rents will moderate in a real estate slump, and his wage growth might offset the drop in his 401K.

[jk]

Re: Interest rate rising for ten years?

i'm not sure how rising interest rates can by themselves produce inflation. you need a slump in the value of the dollar that outweighs the interest rate change

[thriftyandboringinohio]

Re: Interest rate rising for ten years?

i'm not sure how rising interest rates can by themselves produce inflation. you need a slump in the value of the dollar that outweighs the interest rate change

Thanks for the clarity jk.

You are of course right, the fed hiking interest rates is their policy response when they observe inflation.
They do not cause inflation by hiking rates.

I removed that whole idea from the post to avoid further confusion.
I will walk away sheepishly now.....and hope the subject changes back to exploring how to invest assuming rates rise long term.

[dcarrigg]

Re: Interest rate rising for ten years?

My guess would be some bread and butter stuff.

Retail/food trends kids like.
Telecoms/Utilities.
Tax protected munis and state bonds.

Still gotta do your homework. But as broad classes, they should become more attractive as rates rise. Of course, I don't think it will all be smooth. If rates rise too much and exceed dividends, long term money might hop out of utilities and over to US bonds. New bonds will be worth more than old bonds, so I imagine most of the existing bond funds that are holding the bag will take a hit. In theory, higher rates should squeeze down housing prices some, which could put a bit of disposable income back into the hands of youngsters, even if it kills home equity for older folks. But the absolute rate matters here as well, not just the direction. Pensions and endowments should do better as it gets easier to hit return targets with safer investments. Not so clear to me what happens with insurance.

I mean, a lot of times these sort of macro concept plays are dangerous, because I know I don't know any given field with specific enough knowledge to be sure of what's going on. But there are kind of sketchy outlines of a possible broad strategy there. And you could probably play it diversified enough with a percentage of the kitty where if it did outperform, great, and if not, you shouldn't take a huge hit unless everything does at the same time.

[BK]

Re: Interest rate rising for ten years?

Fannie Mae launches a new program to make it easier for home loans to be made https://www.fanniemae.com/singlefamily/day-1-certainty

In order to help with the problem of affordability - Fannie Mae is now offering the waiver of appraisals - https://www.fanniemae.com/content/fa...fact-sheet.pdf

[jk]

Re: Interest rate rising for ten years?

3 to 8 year maturity tips bought at or near par will provide some cushion for your safety allocation- if rates rise faster than inflation the tips will not go below par. a slug of gold to insure against dollar devaluation and/or currency turmoil. non-u.s. equity, both developed and em - if the u.s. economy expands it will pull the em's along, and likely the dm's as well, and again you have a hedge on the value of the dollar.

i'd steer clear of all the dividend plays that have done so well in recent years. they have been the beneficiaries of declining rates and the reach for yield. that will unwind if rates go up with quantitative tightening.

[DSpencer]

Re: Interest rate rising for ten years?

My guess would be some bread and butter stuff.

Retail/food trends kids like.
Telecoms/Utilities.
Tax protected munis and state bonds.

Still gotta do your homework. But as broad classes, they should become more attractive as rates rise. Of course, I don't think it will all be smooth. If rates rise too much and exceed dividends, long term money might hop out of utilities and over to US bonds. New bonds will be worth more than old bonds, so I imagine most of the existing bond funds that are holding the bag will take a hit. In theory, higher rates should squeeze down housing prices some, which could put a bit of disposable income back into the hands of youngsters, even if it kills home equity for older folks. But the absolute rate matters here as well, not just the direction. Pensions and endowments should do better as it gets easier to hit return targets with safer investments. Not so clear to me what happens with insurance.

I mean, a lot of times these sort of macro concept plays are dangerous, because I know I don't know any given field with specific enough knowledge to be sure of what's going on. But there are kind of sketchy outlines of a possible broad strategy there. And you could probably play it diversified enough with a percentage of the kitty where if it did outperform, great, and if not, you shouldn't take a huge hit unless everything does at the same time.

The problem, as you state, is that it wouldn't make sense to buy bonds now if you assume that rates are going to rise significantly. It would only make sense to lock in rates once rates have leveled off or will start declining. So that doesn't answer the question of what makes sense now, given the belief that the Fed will raise rates slowly over the next several years.

It's a difficult question because rising rates hurt existing bondholders but also tend to act as a headwind to stocks. It's further complicated by the fact that if the stock market starts plummeting, the Fed will likely reverse course. That could be an argument to buy stocks, but that assumes lowering the rate will succeed in preventing a market crash. That's pretty suspect in my opinion, especially given that we are not much above zero right now. If you believe in countercyclical monetary policy, raising rates is simply the price that must be paid to return to a position where it's even possible to lower rates during a recession. Basically, if it were easy to make a fortune based on what the Fed Chairman says, everyone would be doing it.

[charliebrown]

Re: Interest rate rising for ten years?

I can't see how rising rates happens. With 350% debt / income levels, rising interest rates means the defaults start happening when entities can't afford the debt service anymore.
Central banks will intervene. I'm not sure how omnipotent they are either. When will faith be lost in both the CB's and the sovereign bonds that are on their balance sheet?
It seems like the entire economy is based on ponzi finance, and people feel much more rich than they really are.

Short term rates are rising in a significant manner. We will see if the trend continues. Long term rates have yet to materially increase.

I think there are too many moving parts, political and emotional concepts at play for me to see how it ends up.
I don't think it ends well.

[jk]

Re: Interest rate rising for ten years?

I can't see how rising rates happens. With 350% debt / income levels, rising interest rates means the defaults start happening when entities can't afford the debt service anymore.
Central banks will intervene. I'm not sure how omnipotent they are either. When will faith be lost in both the CB's and the sovereign bonds that are on their balance sheet?
It seems like the entire economy is based on ponzi finance, and people feel much more rich than they really are.

Short term rates are rising in a significant manner. We will see if the trend continues. Long term rates have yet to materially increase.

I think there are too many moving parts, political and emotional concepts at play for me to see how it ends up.
I don't think it ends well.

i agree. i don't see how they raise rates much OR do anything beyond minimal QT without crashing the economy. debt service is too great a burden.

[Chris Coles]

Re: Interest rate rising for ten years?

Did anyone spot this seemingly small development in the recent speech by Janet Yellen?

"Inflation readings over the past several months have been surprisingly soft, however, and the 12-month change in core PCE prices has fallen to 1.3 percent. The recent softness seems to have been exaggerated by what look like one-off reductions in some categories of prices, especially a large decline in quality-adjusted prices for wireless telephone services. More generally, it is common to see movements in inflation of a few tenths of a percentage point that are hard to explain, and such "surprises" should not really be surprising. My best guess is that these soft readings will not persist, and with the ongoing strengthening of labor markets, I expect inflation to move higher next year. Most of my colleagues on the FOMC agree. In the latest Summary of Economic Projections, my colleagues and I project inflation to move higher next year and to reach 2 percent by 2019.


To be sure, our understanding of the forces that drive inflation is imperfect, and we recognize that this year's low inflation could reflect something more persistent than is reflected in our baseline projections. The fact that a number of other advanced economies are also experiencing persistently low inflation understandably adds to the sense among many analysts that something more structural may be going on. Let me mention a few possibilities of more fundamental influences.

¹First, given that estimates of the natural rate of unemployment are so uncertain, it is possible that there is more slack in U.S. labor markets than is commonly recognized, which may be true for some other advanced economies as well. If so, some further tightening in the labor market might be needed to lift inflation back to 2 percent."

http://www.federalreserve.gov/newsev...n20171015a.htm

[thriftyandboringinohio]

Re: Interest rate rising for ten years?

Thanks Chris, nice find.
The speech you link to was given October 15.
In my original post at the top of this thread, I link to a NYT article covering a speech she gave September 26.

Her two talks are very similar. She say the Fed expects inflation to return to a more normal rate near the target of 2% annually.
And then she goes on and on about the uncertainties of what might cause this inflation, essentially admitting they either can't really explain their thinking, or they are acting for reasons they prefer to hide.
One obvious suspect for a hidden reason is they see a downturn coming and need to raise rates now so they have room to drop them later.

But the theme rings steady throughout both speeches - Fed rates are planned to rise gradually for a while.
Perhaps for a long while.

[jk]

Re: Interest rate rising for ten years?

One obvious suspect for a hidden reason is they see a downturn coming and need to raise rates now so they have room to drop them later.

this is an assertion i've seen many times: they're reloading their "ammunition" for the next downturn. could someone please explain how this course of action would be better than just keeping the rates low? i don't see how having first raised rates, lowering rates back to current levels is more stimulative than KEEPING rates at current levels.

it seems to me they are just preparing to DO SOMETHING visible when the next downturn occurs, so that they are not perceived as helpless.