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The Markets are Bracing for Higher Interest Rates

The generic term for the American economy is now called “the markets” and of course our gambling crazy society focuses on equities just like Clark Griswold at a blackjack table.

Unfortunately for the Hoodies and others who adopted this free wheeling “we’ll always get bailed out by the government” approach to investing, the US 10 year Treasury yield is still running the show. If anyone needs any proof, look at last week’s equity trading even with a day off on Thursday.

The breakout in yields on Friday was due to a “hot” jobs report but the truth is much deeper than that.

There is a belief that the incoming administration will foster a very aggressive fiscal policy to accelerate spending and in fact cut taxes to a point where event 200% tariffs will not offset any cuts that are implement. Add in the fact that there are doubts about the ability of the Fed to contain inflation and the formula is there for the 10 year yield to test the danger zone above 4.90 to 5.05%.

The leak referred to was the hint dropped by Fed insiders that indeed the era of rate hikes was over and the perception that inflation was indeed under control and rate cuts would begin soon. Obviously the rate cuts did not begin until closer to the election thus raising doubts about the Fed’s commitment to fighting inflation as yields began to climb immediately after the first cut.

The stock market indicators every time yields spike, equity markets shudder as the era of easy money for malinvestment might finally be coming to an end. The view over the last five years provides a clear picture of what happens every time yields increase, especially after the 2020 pandemic monetary pump.

Beyond the obvious impacts on consumer credit, the biggest hits will be to credit availability for small businesses, mortgages obviously, and concerns for the ability of corporate America to refinance at affordable rates.

The largest impact will be in housing and as that impacts 15 to 18% of GDP, a progressively increasing 10 year yield will obviously have negative effects. For example, as the yield has increased, housing affordability has declined rapidly since the post-pandemic boom.

Considering the housing markets have not seen the US 10 year yield above 5% since July 2, 2007, a move above that level will be crushing for the industry and affordability for the entry level homebuyer.

The same parallels with the S&P 500 can be found within the housing related exchange traded funds. For example the materials ETF, XLB, has already started to falter with this recent surge in rates since September.

Meanwhile, the newer XLRE ETF which correlates closer to the commercial side of real estate holdings and REITs also reflects the recent move higher in yields.

Considering that this newer ETF has never traded with a 5% plus yield in the 10 year it could see a somewhat spectacular decline when and if this occurs in the next few months.

There are many who are dismissing this price action in the bond market as nothing but “normalization” and will be absorbed by the markets as American innovation will overcome this period. The truth is that the risks of a blowout in rates higher is there because of the massive amount of monetary infusion from the Fed and the speculative fervor which has replaced normal markets.

Buckle up, there’s very little chance that the inexperienced are prepared for the volatility that is about to begin.

(All charts via TradingView.com)

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