@theMarket: Long-Term Interest Rates Will Move Higher
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My motivation for that advice was twofold: the Federal Reserve had cut rates as far as it thought reasonable and my conviction that inflation was moving higher. That proved to be the correct call. Today, I am sounding a warning that the prices of 30-year Treasury bonds (called the Long Bond) are poised to move lower. It will be the first of many moves as interest rates climb higher.
But wait a minute, you say, isn't the economy in recession? Didn't the Federal Reserve just finish cutting rates over the last 12 months to stimulate the economy? Yes to both questions but it isn't the Fed or the recession that bondholders are most worried about. Inflation, the nemesis of the bond market, is the cause of their concern.
Inflation eats away at a bondholder's rate of return and as investor's perception of inflation increases so does their demand for higher real rates of return. Traders will sell bonds and as they do the interest on each bond rises until that point where investors are once again willing to hold these fixed interest obligations.
So how does that impact the stock market? A little back up in rates won't really kill enthusiasm for stocks but as inflation increases and the economy recovers, rates could go even higher and that could spell trouble.
Right now, everyone is focused on inflation thanks largely to the high prices of energy and food. There are even some people arguing that the Fed should begin increasing rates right now before inflation gets any worse.
Personally, I don't think Ben Bernanke and his merry men would do that before the presidential elections. It would just not be the politically correct move to make in an election year; besides, the bond market is perfectly capable of jacking rates up on its own.
Clearly higher rates would offer support to our currency. We have actually seen the dollar begin to stabilize and even strengthen since the last rate cut. A higher greenback would dampen the impact of commodity prices as well since most commodities are priced in dollars.
So on the margin, a bump up in interest rates could actually be good for stocks. But at some point other areas of the economy begin to be impacted. Higher rates on the 30-year bond would definitely put a hurting on the mortgage markets and therefore housing. Higher rates would also slow economic growth since it would cost more for corporations and consumers to borrow. How much higher would rates need to go before severely impacting an already weak economy?
That, my dear reader, could be the trillion-dollar question.
But hey, none of that is important right now. Oil prices dropped this week and are now trading in the $127 per barrel range, down almost $10 from last Friday. As predicted, the stock market rallied on that news and the S&P 500, after breaking support last Friday, is now back at the 1400 level.
Conflicting economic numbers and fluctuating energy prices sent the markets hither and yon but by the close Friday the averages regained part of last week's losses. The Dow was up 1.2 percent, the NASDAQ rose 3.2 percent and the S&P 500 inched up 1.8 percent.
Some folks were hoping that the averages would be up for May, which would have marked two positive months in a row. Alas, we were slightly negative on the S&P, more so on the Dow but the NASDAQ did finish up for the month so it wasn't a total washout.
As a result, expect to hear that NASDAQ and technology stocks are the place to be in June. I've been advising that technology is a "trade" in this market bounce but don't fall in love with the sector. In fact, don't fall in love with anything. As for me, I'll stick with my trading range for right now.
Expect the dollar to bounce, interest rates to move up, commodities to back and fill and stocks to cautiously climb upward on a wall of worry toward 1430 on the S&P 500.
Bill Schmick is a licensed investment adviser representative and portfolio strategist with Berkshire-based Dion Money Management, managing more than $800 million for middle-class Americans from coast to coast. Direct your inquiries to Bill at 1-877-850-7942, Ext. 146, (toll free) or e-mail him at wschmick@dionmm.com. You can also visit www.afewdollarsmore.com for more of Bill's insight.
