|Last week began with the State of the Union address and the President doing the usual boasting and backslapping over the Administration’s first year successes. The only problem, at least as far as the economy is concerned, was the stock market was in the midst of a major selloff, largely attributable to rising interest rates.|
Speaking of our economy, we are in a very unusual situation, where on one hand monetary policy is tightening, while on the other, fiscal policy is of a stimulative nature. With fiscal policy, the Administration is trying to put the gas on the economy with the new tax law changes, the focal point being lower corporate tax rates, as well as adopting a more relaxed regulatory environment. Meanwhile, the Fed’s monetary policy, with their ever-present concern of inflation, is trying to at least tap the brakes by raising the Fed Funds rate and entering bond buyback mode after years of quantitative easing.
So where do we go from here?
By most economists’ estimations, we are at the end of an economic cycle, whereby after 7-8 years of growth, we will eventually hit a plateau and enter a retractment or recessionary period. The predominant viewpoint amongst economists though is that interest rates will continue to rise even more than the upward march we have seen over the last couple of months. Currently, the 10-year T-bond yield sits at 2.84%, a huge upswing from the 2.06 it was at a mere few months ago in early September 2017.
I will take the contrarian view here and predict that rates will at least stabilize and most likely come down once again, whereby the 10-year yield will finish 2018 lower than its present 2.84%. The fact of the matter is that rising interest rates will crimp corporate earnings (why we saw the selloff last week), as well as curbing small investors’ appetite for borrowing, including real estate purchases. There has been a lot of “irrational exuberance” over the last few months and you can bet if the market pullback continues, there will be a reversal of current monetary policy, especially considering the Fed head is now a Donald appointee.
Regardless of if monetary policy eases, expect continued contained (i.e. low) inflation and lower historical interest rates. While I like the attempt to manufacture growth, the reality is that the U.S. is a very mature economy with aging demographics and savings/ investment becoming more skewed to bigger companies and wealthy individuals. Take a look at other similar mature economies with aging demographics, notably Germany and Japan, who have been in an extended period of very low interest rates for many years. Furthermore, while the “Amazonification” of America perhaps has a trickle-down effect on creating jobs, it also squashes a lot of “Mom and Pop” businesses, whose employees will need to find new jobs. Our country’s growth depends upon demand from Main Street America and quite frankly, don’t see the demand will be there if interest rates rise, making borrowing more expensive. Hard-pressed to see any scenario causing rates to jump materially higher.