Oct 13, 2023
As we're sure you've seen, recent headlines have championed the impacts of rising rates and the ‘higher for longer’ regime. Even at Titan we have used these buzzwords to explain some of our in house opinions on the market dynamics unfolding.
It’s fair to wonder, what does this mean exactly?
Bond yields have risen dramatically in recent weeks, so far, in fact, that market participants are claiming that the era of low interest rates is officially over. It’s a bold statement following a four-decade trend of record low rates and a call that has shaken investor confidence.
Since early August, the U.S. ten-year Treasury yield has traded in excess of 4%, a level that hasn’t been seen since 2008. On October 3rd, it hit a 16-year high of 4.8% after rising nearly half a percent in a handful of days. The meteoric rise in rates has been historic and the impacts have the potential to be far reaching.
Longer term rates are correlated with the Federal Reserve’s policy decisions, alongside two additional factors: expectations of how the Fed might change rates in future and “term premium” which compensates investors for any nasty surprises (think: interest rate troubles, government default, or rising inflation).
Both policy expectations (confidence in the path forward) and the term premium (the likelihood for one of those nasty surprises coming to fruition) have contributed to rising yields.
As markets shrugged off regional banking turmoil and forecasted growth was revised upwards, policy expectations changed.
A higher term premium can be attributed to a Treasury that’s been on a borrowing binge (context: from January to September, the US Treasury raised a staggering $1.7 trillion, or 7.5% of GDP), a potential government shutdown threatening stability, a House of Representatives in turmoil, and a wobbly global backdrop.
So what has this meant for markets?
The end of the low interest rate era has led to higher borrowing costs for businesses and consumers. Mortgages are less affordable, the costs of initiating new projects are higher, and businesses are less likely to spend.
Investors can now take advantage of the higher interest paid on low risk securities, making them less likely to invest in riskier assets like equities. We’ve seen this unfolding through record inflows to money market funds. Why put money at risk when you can receive a risk free 5%?
The moves have spilled over globally, as well. Higher rates in America tend to push up the dollar, encouraging other central banks to tighten in order to avoid inflationary pressures from pricier imports.
Rising rates have brought back worries about the sustainability of public finances in the euro zone’s most indebted economy, Italy, as the higher cost of debt may tip the budget to a place that is impossible to repair. Japan has even been forced to artificially cap their ten-year bond yields by entering the market and purchasing bonds in bulk.
The above list is not all encompassing but you can get a feel for how rising rates have the potential to impact all corners of the financial markets. The path forward is uncertain, but if the long era of low rates really is over, many other financial rubicons could be crossed in the months to come.
We’re certain you’ll hear more focus on higher rates moving forward, as headlines and pundits discuss this in detail. Although we cannot predict the unknown, assessing the probabilities and staying the course have arguably never been more important than it is today.
Have a great weekend,
- Your Titan Team
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