Wall Of Worry Now Includes Rising Yields

October 9, 2018

Interest rates have risen to levels where they are finally getting noticed, even on giddy Wall Street and in the undiscerning precincts of television business news. In recent days, nasty selloffs in the stock market have been attributed to correspondingly large leaps in Treasury yields. The move since late August has been unusually steep.

The Ten-Year Note hit 3.25% on Monday, up from  2.83% just five weeks earlier, while the 30-Year reached 3.42%, up from 2.98% during the same period. Rick’s Picks was well ahead of this economically threatening development with a bearish call and a 3.11% target for the 10-Year that went out to subscribers in 2017 when rates were hovering around 2.54%. The 3.11% target was precisely achieved in mid-May, and at the time, we expected it to mark an important top. But the subsequent pullback was so obviously corrective that we raised our targets to levels that lie not far above today’s peaks. With this edition of The Morning Line, however, we are raising the targets yet again to, respectively, 3.59% on the long bond and 3.47% on the T-Note.

Why Yields Are Rising

The upward pressure on rates is being caused by several factors. For one, the Fed has reduced its borrowing and ‘tapered’ its balance sheet by selling Treasury debt on the open market.  In addition, the U.S. economy has been strong, CPI inflation, at 2.9%, has risen significantly since a year ago, commodity prices have recently firmed, and foreigners, most particularly China, have been dishoarding U.S. paper.

We’ve long expected that the higher rates we were predicting would choke off the economic boom and cause stocks to fall. The latter effect has taken longer than we’d anticipated and required an in-Wall-Street’s-face breakout in yields to get the message across to bubbleheaded portfolio managers. It remains to be seen whether yields will go high enough to put the U.S. economy in recession. Regardless, we expect the rate rise to be self-limiting, since it will reduce the economic activity that causes yields to move higher in the first place. Mortgage borrowing is already sluggish because the housing sector has peaked, and money managers will be buying more bonds at the long end of the yield curve as the bonds’ higher returns make them more attractive relative to stocks. Economic slowdowns gathering force in Europe and China will further suppress the rise in rates and suck some of the hot air from America’s boom.  Under the circumstances, we would expect the 3.47% and 3.59% targets given above to mark the top of the bull market in yields begun in the summer of 2016.

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The world’s gold supply increases by 2,600 tons per year versus the U.S. steel production of 11,000 tons per hour.