It is essential to understand the impact of rates on a heavily leveraged economy.

1) Economic growth is still dependent on massive levels of monetary interventions. An increase in rates curtails growth as rising borrowing costs slows consumption.

2) The Federal Reserve runs the world’s largest hedge fund with over $7.5-Trillion in assets. Long Term Capital Mgmt., which managed only $100 billion, nearly derailed the economy when rising rates caused its collapse. The Fed is 75x that size.

3) Rising interest rates will immediately slow the housing market. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in interest rates means higher borrowing costs which lowers profit margins for corporations.

5) One of the main bullish arguments over the last 11-years remains stocks are cheap based on low interest rates. That will change very quickly.

6) The negative impact on the massive derivatives market could lead to another credit crisis as rate-spread derivatives go bust.

7) As rates increase, so do the variable rate interest payments on credit cards. With the consumer already impacted by stagnant wages, under-employment, and high costs of living; a rise in debt payments would further curtail disposable incomes. Such would lead to a contraction in spending and rising defaults. (Which are already happening as we speak)

8) Rising defaults on the debt will negatively impact banks that are still not adequately capitalized and still burdened by massive levels of bad debt.

9) Commodities, which are sensitive to the direction and strength of the global economy, will revert as economic growth slows.

10) The deficit/GDP ratio will surge as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new estimates begin to propel higher.

 

Higher Worldwide Interest Rates

 

The global bond rout is picking up momentum. Most bond yields are still below 2019 levels but are rising quickly.

• The US:

 

 

• Australia and New Zealand:

 

 

 

• Japan:

 

 

• South Korea:

 

 

Emerging markets’ local-currency bonds are also selling off.

• India:

 

 

• Thailand:

 

 

• Indonesia:

 

 

The recent yield increases are comparable to what we saw during the 2013 taper-tantrum when the market lost 20% in a month because the Fed said they will be raising rates.

 

 

US copper futures blasted past $4.0/lb, hitting the highest level since 2011.

 

 

 

 

 

Rising corporate bond yields are a risk to the S&P 500 rally.

 

 

Bloomberg’s spot commodity index hit a multi-year high.

 

 

Oil, silver, copper, and corn all shot up this month, pushing commodities up around 50% on the year.

Milk prices are up 6.6% over the past 12 months, ground beef is up 5.1%, and the price of a standard bicycle has gone up 39.3% since a year ago.

 

US Economy

 

  • The preliminary Markit PMI report showed strong business activity this month.
  • But supplier bottlenecks appear to be worsening which is pushing input prices higher. In some cases, businesses have been able to pass these higher prices on to their customers.
  • Rising producer prices are making their way to the consumers.
  • Existing home sales were quite strong in January (almost 16% above Jan 2020 levels).
  • The inventory of homes for sale hit a multi-decade low.
  • Job openings continue to climb.
  • Gains in input costs are accelerating, forcing some manufacturers to boost prices for finished goods.
  • Forward-looking economic indicators pulled back.
  • According to the the Conference Board, consumer confidence ticked higher this month as the pandemic situation improves.
  • The Conference Board’s labor differential (“jobs plentiful” less “jobs hard to get”) remains depressed. This is the main reason the Fed wants to keep QE going.
  • Inflation expectations remain elevated, driven by food prices

 

 

  • Home price appreciation (based on Case-Shiller) exceeded 10% in December (year-over-year).
  • The gap between wages and home prices continues to widen.
  • The Richmond Fed’s manufacturing report shows robust activity in the region.
  • However, the index of expected new orders slumped this year.
  • Factories are having a tough time finding qualified workers.
  • Companies (particularly retailers) have rebuilt inventories.
  • Many service firms are having a tough time passing on higher costs to their customers.
  • Loan applications to purchase a home declined last week.
  • Personal incomes rose sharply in January, boosted by one-time government checks and elevated unemployment payments
  • All of the gains in income came from government support. The contribution from private sources was negative again
  • Spending rose in line with expectations, with the bulk of the income increase going into savings.
  • Here is a comment from Alex Pelle, Mizuho Securities USA.

“… the saving rate skyrocketed to 20.5% from 13.4% of disposable income. This implies a consumption multiplier close to $0.20 for every $1.00 of government transfer. This does raise serious questions about the wisdom of another giant stimulus. However, over-heating concerns can be somewhat eased by the evidence that transfer payments or “relief” do not seem to be very effective as stimulus: Most of the transfers are being saved by households.”

  • The Chicago PMI indicator softened in February, but business activity remains robust. It suggests a modest pullback in factory activity at the national level.

 

Debt

 

US government receipts and outlays:

 

 

 

The planned $1.9 T COVID bill can close the GDP gap, with a trillion or more to spare.

 

COVID Update

 

Vaccinations continue to ramp up, the new Johnson & Johnson (JNJ) single-dose vaccine will likely be approved by the end of the month – bringing massive new supply online – and as you can see from the charts below cases, hospitalizations, and average daily deaths are plunging – they’re now down 74%, 58%, and 43%, respectively, from their peaks only five weeks ago:

 

 

More than 63 million Americans have already received inoculations through yesterday, according to Bloomberg’s COVID-19 vaccine tracker. The average daily total is 1.33 million doses administered per day over the last week. That’s tremendous progress compared with where we were at the end of 2020, with only 3 million vaccinations.

In the US, hospitalizations for those age 85 and older dropped 81% from January to February, according to Bloomberg.

 

 

 

 

All content is the opinion of Brian J. Decker