Interest rates on the benchmark 10 Year Treasury Note have risen from 1.9% the other week to 2.25% today. On the surface that appears to be little cause for alarm since rates were peaking above 3% just over a year ago and remain historically VERY low. However, today rates jumped sharply on the sudden realization that confidence in a Fed rate hike this year was no longer a 50 – 50 proposition, but nearly 100%! Why? Today both the US and Europe reported much stronger than expected economic data and forecasts – and this is before the massive Quantitative Easing (QE) Bond buying program in Europe has even begun. Our recent newsletter this week talked of our expectation that US stock indices would have a large enough correction over the next 12 months once rate hikes became inevitable that should scare investors. Such a move would require more than the 10% drop last October which scared very few and likely a fall below the 4th quarter low which would be a 15% pullback. Should these 10 Year rates rise quickly to 3% this year it would likely cause reduced Price to Earnings multiples for stocks, lower forecasts and much lower stock prices – at least temporarily – perhaps more than 20%.
So far stocks are only off a couple percent which is a blink of an eye. Our quick update today is just a warning that an interest rate rise of a secular nature which has been elusive in recent years could be starting. What will delay this broad uptrend in interest rates and add new fuel to stocks? Oil prices falling to new lows in the lower $40’s would tell the markets that deflation is just too strong and with Global interest rates falling that the Fed will delay rate hikes. Stocks would likely surge enthusiastically should Oil fall far enough to prompt US stimulus and low rates to remain in place.
Many knew the economy in the US was becoming stronger and that Europe would follow later this year. However, it was widely assumed that weather would slow the US this quarter and that Europe was still months away from growth that would cause credit rates to rise. The reports today were the straw that broke the camels back and confirmed that job growth in the US is much stronger right now than believed and that Germany and Europe are about to grow much faster, even before stimulus kicks in. Should the markets keep falling next week we should expect the Fed to make a statement that they are maintaining their wait and see approach until the summer before considering rate hikes. Until then or until Oil falls further we should watch the support levels outlined above.
As we said, Oil is a wild card for the short to medium term that could delay the US rate rise. A break to new lows on this chart (below) will signal to the markets that the Fed will maintain patience and delay Selling Bonds into the free markets that would pressure rates higher. Moving above $55 would only add pressure for rate hikes sooner than expected and thus lower stock price multiples temporarily.
Despite the slight dip in the Yen this week, prices remain within the key trading range (like Oil) we mentioned earlier this week to watch for. A collapse in the Yen “should” send US stocks higher, while a rally in the Yen and Oil above their recent trading ranges should add downside pressure onto US stock indices (DJIA/SP 500/Nasdaq).
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