Why Are Interest Rates Headed Higher?
Posted by Larry Doyle on March 1, 2009 3:57 PM |
While our domestic stock markets are down approximately 50% over the last 14 months, there has been a rush of cash into short term money market funds, government bond funds, and in the last few months corporate bond funds and municipal bond funds. As I mentioned in my February 2009 Market Review, I am increasingly nervous about bond investments at this juncture. Why? I’m glad you asked.
1. Primarily due to the massive global government funding needs which are just starting to hit the market. In a recent piece, the highly regarded Financial Times projects global government debt issuance to TRIPLE in 2009.
German Prime Minister Angela Merkel is concerned about European countries looking to tap the markets on or near the same dates. She is proposing global coordination of debt issuance so as to insure that rates are not DRIVEN higher.
2. Sovereign credit risks are increasing dramatically. Not long ago, Irish government debt traded in line with German Bunds (government debt). Irish 10yr debt now trades at a premium of 2.5% to that German debt. This phenomena is destabilizing for the European Community at large and for those countries (Ireland, Portugal and Greece) in greatest distress. If we do experience a sovereign default then there is a chance that we will have a flight to quality with capital flowing to the United States.
3. Here in the United States our government and private debt will soon exceed 100% of GDP. Analysts estimate that the U.S. will issue $2.6 trillion in net additional debt in calendar 2009!! Our 2yr Treasury note is up 25 basis points (.25%) year to date while our 10yr Treasury note is up 80 basis points (.80%). Remember rates up, bond values down. These moves are significant especially in light of a stock market that is down almost 20% year to date!!
4. Who else needs money? Banks, insurance companies, pension funds, municipalities, consumers, automotive companies, private corporations, et al!!
Municipalities specifically will need to raise taxes and issue debt to replenish their coffers and especially their pension obligations. Both of those moves will pressure consumers and housing and further exacerbate our current economic distress.
5. Bonds have dramatically outperformed stocks in the first two months of 2009 but I now feel a wave of bond issuance coming and with the crowding out effect becoming ever more problematic, I believe these interest rates have the potential to ratchet higher.
None other than Warren Buffet himself cautioned against a bubble in the U.S. Treasury market.
Again, I caution people to review their overall asset/liability situation, work to cut expenses, and consult with their own financial planner. Given what I see on the horizon, though, cash will continue to be the best place to hang out while this hurricane blows through our global economy.