Before the Feds Emergency rate cut on Friday the bias was to higher rates across the board. For example the Australian Reserve Bank increased prime interest rates by 0.25% and even now after the stock market pummeling, continues to warn of more to come. This article explains why interest rates are about to go higher at exactly the WORST possible time.
The question foremost on investors minds is whether a turbulent stock market warrants halting interest rate increases or, in the case of the US, decreasing rates to resuscitate the Real Estate, options and credit markets.
It never ceases to amaze us that central bankers blame price inflation for increasing interest rates when in fact it is their own money printing that causes price levels to rise. The simple fact is that global printing presses have run too hard for too long for anyone to be able to prevent price levels from breaking out. This leaves jawboning and raising interest rate as the only effective tools in controlling the public perception on inflation. In other words, inflation is now baked in the cake and in the world of central banking (where perception is king) the blame is put on stronger than expected global growth.
Boil it down for us Greg. What does it all mean?
It means we are in for higher interest rates across the entire yield curve at exactly the WORST possible time:
Chart 1 – Australia 1 month Bank Bill prime interest rates
The recent hike in interest rates by the Reserve Bank of Australia caused rates to break above previous support (red line) and painted a target of 8.25% (green line).
Australia has lead the charge on inflation because its economy is so sensitive to underlying commodity price pressures.
Up until now the treasury market has been the major recipient of a flight to quality. But as chart 2 shows, Bonds are about to hit some headwinds as they approach support in the form of a long-term rising trend line.
Chart 2 – Bonds are approaching Long-term support (lower blue line)
The implications of the above chart is that long-term yields are about to reverse higher. There are 2 possible scenarios we could envisage which would cause Bonds to lose their safe haven status:
1 – The strong global growth scenario regains dominance, perceived market risk decreases and inflation has its way.
2 – The credit market contagion spreads into AAA paper and finally into treasuries causing the US Dollar to drop like a stone.
It seems improbable (to us at least) that scenario 1 will play out due to the extent of the credit market problems. Which leaves scenario 2 as our highest probability outcome.