Secular Trend Review
We have been consistent in our view that the secular trend in interest rates is up rather than down and that increasing interest rates are good for the market. Our view preceded the Federal Reserve’s policy of rate increases starting December 15, 2015.
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“A single rate increase by the Federal Reserve in no way makes for a trend. However, markets often lead the way and what initially seems “bizarre” is only a natural change in regime, a change that we haven’t seen since the early 1940’s (December 16, 2015.).”
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“We’ve only included the point in the interest rate cycle that corresponds to the phase that we are entering, coming from an all-time low to an eventual all-time high (November 15, 2015.).”
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“Investors anticipating a general rise in interest rates should feel some comfort in knowing that most manager(s) in the utility sector are ready for what is to come. Rising interest rates are not an automatic death sentence for utility stock prices or earnings. In fact, the early stages of rising interest rates may see utility stocks match or exceed the returns of non-interest rate sensitive stocks, on a total return basis. Only when the outlook is cloudy will it become difficult to offer projections that are in line with prior expectations (September 4, 2014.).”
Cyclical Trend Review
In spite of the secular trend, we have also called the rate decline based on “price action” irrespective of the talk about what the Fed should or shouldn’t do.
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On January 23, 2019, we provided our first downside targets for interest rates. At the time, we had the 3-month treasury slated for a potential downside (in the extreme) of 0.83% from the level of 2.45%.
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On April 23, 2019, with the 3-month Treasury at 2.45%, we said the following: “If the current run of stability in rates is anything like the period of 2015 to 2016, we should see a sharp drop in rates as was seen in the period from September 12, 2016 to September 22, 2016. At that time, the 3-month treasury dropped from 0.37% to 0.18%, a decline of -51%.”
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On December 6, 2019, with the 3-month Treasury at 1.53%, we said: “If the November 1, 2019 low, at 1.52%, is broken then we can reasonably expect at least another decline to the 1.30% level and maybe more before another rate cut by the Federal Reserve.”
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On March 3, 2020, when the 3-month Treasury sat at 0.95%, the Fed decided to do an “emergency cut” in interest rates.
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On March 16, 2020, when the 3-month Treasury sat at 0.24%, the Fed cut rates to zero.
All of the actions of the Fed were preceded by the change in the overall trend of the 3-month Treasury. Our take on what is next is below.
As we said on March 27, 2020:
“The door has been closed on the rate cutting tool that the Federal Reserve has wielded like a force field against any perceived threat to the economy. However, the reality is that we’re in a secular rising trend in interest rates. ANY additional stimulus (fiscal or monetary) should be looked upon as prolonging the problem rather than improving or fixing the problem.”
Rate Reset
Going forward Fed rates should increase. Already we’re seeing the 3-month Treasury making a rebound from the March 26, 2020 low. What we don’t know is the amount of increase before the Fed decides to follow.
In the last rate increase cycle, the Fed responded after the 3-month Treasury increased to 0.27%. We are currently sitting at the 0.11% level for the 3-month Treasury. If the past is any indication, rates have some time before they are actually increased by the Fed. We’re willing to be surprised however with a sudden rate increase. Either way, rates are going up.