Was it just days ago that deplorables in the steerage section guffawed the suggestion rates might be going up? No respect. The beatings, as they say, will therefore continue until morale improves.
Well, guess what? Everything may be changing. And your hero, Trump the Munificent, is the guy to blame.
Forget the inverted yield curve. Forget the recession. Forget a stock market correction. We’re goin’ to Mars with Elon and Donald. Oh, and that Xi dude. Money is on the move. Out of bonds. Into equities. Risk on.
As you know, that sexy US Commerce Secretary, Wilbur Ross, has indicated ‘phase one’ of a US-China trade deal is nearly ready to ink. Expect a big signing ceremony. Washington is letting tech companies deal with Huawei again. Beijing will be Hoovering up a mess of American agricultural products (including ours). Tariffs slated to become effective next month will be waived. This is the beginning of a pre-2020 electoral charm offensive the American president will use to ensure roaring markets, full employment and steady GDP growth into next year.
Assets are responding. Naturally. This is a big deal for the global economy, ensuring more growth, less protectionism, reduced trading costs, enhanced profitability – and no recession. In reaction the yield curve is flaccid no longer, but stiffening nicely.
Says one Wall Street analyst: “Brexit, impeachment, budget deficit, lack of a budget — none of those things are affecting the market at this point. … How quickly you resumed higher rates and how quickly the curve is steepening out tells me the trend is changing, and we’re moving to a very large trend higher in interest rates.”
Already happening. Bond yields have moved up since the trade announcement. Meanwhile the Fed – although it nipped its key rate another quarter point just days ago – clearly signaled it wants to pause. The cuts so far (three of them) were insurance against a potential slowing of the economy if the trade war continued. Now, if Ross is truthy, the insurance is not required. In fact more economic growth, more inflation, lower employment, wage demands and record equity market levels may lead to a Fed tightening. As stated here a few days ago, this will also make our guys at the Bank of Beavers look like clairvoyants for having resisted the urge to make money cheaper.
It means US 10-year bonds, which plunged in yield to the 1.4% level during the summer (lower than what short-term debt was paying – hence the ‘inverted’ yield) are on their way back to the 2% range. Now add in the solid jobs gains the US announced last week – despite the big GM strike – and it shows the economy is alive and kicking. This even has oil ticking higher, as Mr. Market looks at the America-China deal as a big unwinding of the populism and nationalism that just months ago seemed dire.
Sorry, Trumpers. Your guy just pivoted. But we knew he would.
Anyway, whazzit mean?
Well, CBs never really wanted to reduce rates, but the Trump-Xi war scared them into it. The bankers would love to have the cost of money normalize so debt growth can be contained while giving them real ammo to deal with the next recession. Rates are too close to zero and need to increase simply in the name of risk management. (Dropping them adds stimulus, and is the CBs’ main monetary tool for shortening and shallowing contractions. Like in 2009.)
Rates will rise, not fall, if protectionist sentiment gives way again to trade deals. The forces of globalism will win, since human wealth depends on its success. MAGA, Brexit, Wexit etc. are fun attempts to blow stuff up and see what happens, but they’ll be swept asunder by corporate internationalism. You think you can stand in the way of Jeff Bezos? Good luck with that.
Anyway, if you’re gambling on rate declines by borrowing short or with a variable-rate loan, this might not end well. Five-year fixed-rate mortgages are incredibly cheap at 2.5-3% and provide a lot of security.
But how about a 10-year mortgage? There was an interesting argument in favour of the decade-loan loan published on one of the mortgage-humping sites this week (RateSpy). The difference between a fiver and a ten is so small at the moment (less than half a point) that this is a very viable option for anyone wanting to know what they’ll be having for breakfast in 2028. It’s worth noting, as well, that 10-year mortgages under the Canada Interest Act become open loans after five years. They can be paid off at any time in the second half of their lives with a simple three-month interest penalty.
The downside of a 10-year is you’ll pay a bit of a premium for the first half over a conventional five-year loan. But you’ve purchased protection for the next five. There’s little doubt, when you think about it, that rates will be higher in the future – since we’ve been sitting at historic lows for most of a decade. More global growth is a certainty. Technological advance is guaranteed. And huge sums will be required over the next decade to deal with rapidly-changing demographics, the AI revolution and, yeah, climate change. If you doubt where we’re headed, just spend tonight watching TikTok. Your life will change.