Yahoo Finance Interest rates up 8 times in the next 2 years? True or False?
Do you wonder what direction interest rates will take? Do you feel worried that you’ve borrowed a lot and rates could rise? Well, the former RBA director and former banking chief economist, John Edwards, appeared on my Sky Business TV program this week and I wanted him to respond to media reports that said he maintained interest rates could rise eight times over the next two years
Panic among home borrowers
This has spread fear into the hearts and wallets of those over-borrowed types with home loans. If John’s claims were correct, retirees, who love the security of term deposits, would be icing up the champagne bottles for 2019!
Typical media misreporting
John said the story was taken out of context. His message was that if we grow as fast as the Reserve Bank thinks (over 3% for a couple of years) then rates could rise faster than expected.
He thinks we will grow slightly slower but still at pretty good rates. He also thinks the RBA won’t rush to raise rates while the dollar remains so strong. It’s now over 77 US cents!
Rate hikes means growing economy
While rate rise talk can be scary, it actually talks to an improving economy where jobs will be created, savers will get better interest rates and our economy would throw off the black clouds that have followed us since the GFC.
By the way, Edwards actually agreed with me that because of over-borrowing by many to purchase expensive homes, the RBA might not have to raise rates by much to get a big bang for its buck.
Effect on share market
But what does all this rising rates talk mean for stocks?
The best one-year term deposit rate in Australia right now is 2.75% at Bank Australia. If we saw the cash rate rise by 2% in two years, a rate of 4.75% could start attracting money out of the stock market. It could be a precursor to a big market shake out but it would imply that for the next two years, the stock market could go gangbusters.
How realistic is this?
In recent weeks, the bond market, which some argue borders on infallibility (I’m not one of them) has been putting up yields. This has sparked a bit of negative volatility on stock markets but I’d argue this is the reaction of short-term players, who need to rejig their investment/trading plays.
For the long-term investor, the higher yields are actually saying: “We, the bond market experts, got it wrong earlier this year when we started buying bonds, driving up bond prices and sending yields lower”.
The bond market was too negative on the economic outlook then, and now it might be becoming too positive. Whatever the real story, at least I think they’re getting it right now.
What about the USA?
Fortunately late this week, the US central bank boss, Janet Yellen, confirmed that her economy was doing well but that rates will only rise gradually. This made the bond market lower yields on bonds, which weakened the US dollar, strengthened the $A and helped stocks go higher.
Nice work, Janet
Relationship between bond and stock markets
The link between the bond market and the stock market often gets clouded when you see the likes of Bloomberg run with a headline such as: “Bond Markets Positive Vibes Suddenly Disappear.”
This is saying that the demand for bonds is set to fall, so bond prices drop and yields go up. But the question you have to ask is: why?
The two big reasons that the markets have concentrated on have been that central banks will be raising interest rates and they’ll be selling bonds after a near decade of buying the suckers to rescue the world economy from recession.
The world is growing
What gets lost in this bond market drama is the fact that the world economy is getting stronger. Last weekend, we saw the US economy created 222,000 jobs in June, when only 179,000 were expected.
And this from Bloomberg emphasizes my point: “After months of disappointing economic data, growth trends look more positive. The Federal Reserve Bank of Atlanta’s GDPNow index puts second-quarter GDP at a solid 2.7%, and third-quarter estimates are in the same neighbourhood. Those kinds of numbers would give the Fed a clear path to hike in December, even though the market has roughly 68% of such a move priced in as of Wednesday.”
This can’t be bad news for stocks, which interests me more than the bond market.
A CNBC headline such as this: “The Party is over: central banks pull the plug on bond market” could worry some investors but again the focus is on the bond market.
My gut says things are better
Sure, easy interest rate policies also helped stocks and if the global economic outlook wasn’t on the improve, I’d be worried. But it is. This chart showing how well Purchasing Managers’ Indices are doing proves my point:
Then there’s this chart, showing the EPSs of global stock markets are also heading up in a synchronized way for the first time since 2010. This has to be a plus for stocks.
This is an important piece of evidence suggesting that the stock market’s bull run still has some upside and European interest rates going from negative to just positive shouldn’t have an immediate impact on this bullishness. Neither should US rates only sneaking up in a measured way, and that’s exactly what Janet told us this week.
Some things could rock stocks
I know there are some curve balls out there that could make the stock market strike out in the short term but it would more than likely be a buying opportunity.
Remember, this good economic news is happening without much help from President Donald Trump’s tax policies but if they get up, say in 2018 ahead of the mid-term elections late in the year, then the positive market momentum would be guaranteed.
What about these 8 rate rises here?
Eight interest rate rises in two years? I always doubted this. If this happens, then our economy would be growing close to 4%, inflation would be rising, wages would be spiking much faster than now and stocks would’ve had two good years.
Then I could be seriously thinking about taking profits and waiting to see how high rates would go but this is a highly speculative scenario.
For the time being, I remain positive on stocks while being wary of another sell off, after which I’d be a happy buyer. That said, given the good run of economic data, maybe the sell off has already happened.
This is my preferred position and this week’s stock movements haven’t changed my view.
Peter Switzer is the founder of the Switzer Super Report, a newsletter and website for self-managed super funds.
