This should be of INTEREST for all of us

Published on: 16:01PM Jan 10, 2018

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10Seeing that the grain and soy markets appear intent on grinding sideways into the Friday reports, we may as well take a look at another market and one that could hold implications for all of us; Interest rates.  Needless to say, over the past couple years we have heard endless discussion about if and when the Fed would begin to raise rates from the historic lows as well as the timing as to when they would begin unwinding the bond purchase program that was all part of the plan to stimulate the economy after the great recession(QE).  Of course, they have been boosting rates, the last time in December with Fed Funds now up to a staggering 1.25 to 1.50%, and the unwinding has been underway. This has created a sideways to lower pattern in the financial instrument markets (inverse relationship) but never quite as severe as might be expected by the hikes as well as the forward guidance from the Fed. That is until maybe right now. 10-year notes poked in a high for 2017 back in September and have steadily pressed lower.  We have witnessed several up and down swings since the extreme high back in 2012 and by no means is this the first time we have visited the current price level, but there are a few things that could suggest that we will not stop here this time.  The first and most obvious is that the market already expects the Fed to boost rates a couple more time this year but the other concerns another governmental influence, but in this case that government is China. It is common knowledge that China is a massive holder of US treasuries, and while they did begin to sell them off in late 2016, that was reversed in 2017 and by the end of the year they once again have reached back to the $1.2 trillion level, which accounts for over 25% of all foreign ownership.  Again, there is nothing new about this, but there is talk that Senior officials in China are now recommending that they curtail or even halt any further purchases.  If the Chinese are not buying and the Fed is no longer rolling ahead existing purchases who then is there to finance our deficit spending? Granted, this is just talk at this point and considering our trade relations are a touch strained right now, may be little more than positioning for further negotiations, but obviously, the markets are beginning to take it seriously.

NotesOf course, higher interest rates would technically create a drag on business and spending and could represent a death knell for the equity trade.  Note that coming out of the recession, financial instruments (here represented by 10-year notes) and equities advanced in tandem with each other, but began separating in mid-2016.  I believe few would argue that part of the stimulus that has continued to drive equity markets higher is the fact that they were the only game in town.  If interest rates do continue to move higher (notes lower) and there is a little general uncertainty about economic trends or the threat of war, etc., that could change rather quickly.  The recent flattening in the yield curve has also been a warning signal that the end is approaching for the equity rally. One caveat in all of this, technically higher interest rates are often dollar supportive, but if nations like China are no longer purchasing our debt instruments, there may be less demand for dollars as well.   

These are all interesting possibilities, and I believe, reconfirm my outlook that we have entered a major transition period when equities, for a while at least, will no longer be king of the hill and commodities will begin to shine brighter.