Why Higher Rates Ain’t Here to Stay

by Dan Burrows | June 14, 2013 1:16 pm

Pity poor Federal Reserve Chairman Ben Bernanke when he meets the press following next week’s regular meeting of the bank’s rate-setting committee. No matter what he says, the market just doesn’t seem to listen.

Bernanke’s predecessor Alan Greenspan famously kept his public pronouncements so vague and inscrutable that no one knew what the hell he was talking about.

But Bernanke is the opposite. He ushered in an era of clearer, more explicit Fed statements and lots more transparency. He even started the practice of holding press conferences following Fed meetings.


Because no one seems to believe what he says, anyway — no matter how many times he says it.

Bernanke keeps saying that low rates across the yield curve are here to stay until the economy and inflation show that the recovery is for real. And yet long-term interest rates are spiking, clobbering bonds, REITs, preferred shares and anything else that’s rate sensitive.

The yield on the benchmark 10-year Treasury note hit a 14-month high of 2.29% on June 10. As recently as May 2, the yield closed at 1.63%. And that 40% jump in yields had nothing to do with Fed policy. After all, short-term rates are still at zero and the central bank is still buying up bonds at the longer end of the yield curve.

Rather, rates are rising on market fears that the Federal Reserve is set to reduce — or taper — its program of spending $85 billion a month to buy up Treasurys and other longer-term debt.

This seems really unlikely, at least if Bernanke’s repeated statements are to be believed. Yes, the Fed chief did acknowledge that the central bank could begin tapering its bond-buying program if the economy were to show “continued” and “sustained” improvement.

But it’s not.

The data points aren’t bad, but they’re hardly uniformly good. It’s mostly a case of two steps forward, one step back.

The Fed also has an inflation target — and the economy is missing it by a wide mark.

The Fed’s preferred inflation measure is personal consumption expenditures excluding volatile food and energy prices (core PCE). It wants to see this figure hit 2%. And the latest reading on core PCE showed an increase of 1.1% year-over-year. That’s the lowest level ever recorded in the index, which dates back to 1959. The Fed is desperately trying to goose inflation — and it can’t.

Furthermore, Bernanke is a scholar of the Great Depression. He knows better than anyone that premature Fed tightening in 1936-1937 choked off the recovery and sent the economy back into a tailspin.

The economic and inflation data just don’t support imminent tapering or tightening. And even if the economy turned on a dime and started creating tons of jobs and tightening looked unavoidable, since when are we afraid of things getting better? True, rising interest rates are bad for bonds, REITs, MLPs. So what? You know what else is bad for these things?

A crappy economy and 12 million people who can’t find work.

Fretting over Fed policy makes sense it you’re a trader. But if you’re a long-term investor trying to save for you kid’s college education or your own retirement, then the end of easy money monetary policy is ultimately good thing. As investment advisor Josh Brown says[1]:

“I’d rather a strong jobs number and a path out of this stagnation than more excuses for stimulus. But that’s just me, someone who is more concerned with economic progress for America as opposed to this month’s trading P&L.”

The Fed will tighten when the economy can indubitably support itself. And a healthy economy is better for your long-term holdings than the Fed’s policy of monetary madness. Think about it that way, and there’s no reason to fear higher rates down the road. They’ll signal a return to real growth — to normalcy.

But we are nowhere near accelerating to sustainable growth — or a return to normalcy. The fundamentals don’t support the spike in interest rates lasting all that long.

Bond king Jeff Gundlach of DoubleLine Capital says the 10-year Treasury will be back at 1.7% by the end of the year. I wouldn’t bet against him.

  1. As investment advisor Josh Brown says: http://www.thereformedbroker.com/2013/06/07/whats-wrong-with-you/

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