Rates on the Rise | January 12, 2018

Equities have surged while bonds have retreated. The rate environment has people wondering if “low for long” has finally come to an end.

Globally, there seems to be a synchronization in central banker sentiment. 2018 could very well be the year they lean away from accommodation.

  1. The US had already begun the process last year by reducing its balance sheet.
  2. The EU has begun to taper their purchase program, which is a reduction of accommodation, not tightening of policy.
  3. Last week, Japan announced that they were going to begin reducing their purchase program.

Central banks have been crucial buyers of sovereign debt over the last decade. Rates will rise as they head for the exits. If this happens gradually, then the impact will be modest, as the interest they put off will offset the price swing. This is probably the most controllable aspect of our current rate environment.

Another major buyer of Treasuries decided to rattle some cages last week. It was leaked that China was considering reducing or potentially eliminating its purchase of Treasuries. This caused a short-term rate increase as another large buyer would be heading for the exit. They later denied the claims, as they should. Given their trade relationship, it makes sense to maintain a strong interest in US Treasuries for currency value stability.

Much has been made of the link between German yields and US yields. With German yields still under 1%, many find it hard to believe US rates can increase much above current levels. An increase in the spread would actually push buyers out of the German market and towards the US. First, leveling out our rates, and second, pushing German rates up. This is something the German economy and EU as a whole would likely want to avoid for the next few years.

The controllable events seem to point to a gradually rising rate environment. The uncontrollable, a correction, not only is always present, but with each passing upward month on the markets, it becomes more likely. The risk being that in the short-term, rates would fall in response. Inevitably, corrections aside, rates will likely continue to rise as the expansion wears on. As GDP rises, as should rates, maintaining their natural, nominal relationship.


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