U.S. Dollar and Interest Rates
As the U.S. Federal Reserve begins to taper down its asset purchase program, shifting funds out of bonds, and into equities, we could see the U.S. Government losing control of interest rates. The 10-year Note could hit rates between 5 to 6 percent in the next 18 to 24 months.
The ascent of interest rates has only begun. The Fed is already losing its grip. What we can see happening is simple: the yield curve will steepen at first, then it will shift. This will move rates higher and higher making the government’s cost to borrow money in order to stimulate the economy more expensive. If this rotation from bonds to equities does happen, in other words funds shift from bond purchases to equities, rates will soar and the government will not be able to control it. For right now, we are seeing money shifting from bonds to cash and not equities, this could change.
Should this happen and this scenario unfolds, we will start seeing the 10 year yield begin to rise towards 3.5 to 4 percent, once that happens it can jump right to 5 percent and maybe even 6 percent within the next two years. We have not seen the 10 year note at 6 percent since 2000.
Investors will start shifting funds, once they begin to realize they are losing money on their bond portfolios. This could shift into a market frenzy quickly causing a selloff in bonds. Since interest rates and bond rates have an inverse relationship, the value of the bonds will decline and the interest rate will increase.
Looking at the below chart, we can tell that 10 year yields have been rising faster than expected over the recent months. This is happening, simply on expectations that the U.S. Federal Reserve is going to taper back its massive bond buying program at some point later this year. Earlier this month the yields jumped up to 2.73 percent. This is the highest level seen since August 2011. In May, rates were at 1.7 percent.
U.S. 10 Year T Note Rates Climb
The bond market has an inflection point within the U.S. interest rate cycle. This lasts around 30 years. The last time rate spiked like this was around 1983, or 30 years ago. Rates are in a trough right now. It is this point the U.S. Fed wants to maintain control for as long as possible.
This rise in rates will have repercussions throughout the currency market. We are already starting to see the U.S. Dollar strengthen as foreign bonds drop and interest rates on the U.S. bonds rise. If the dollar continues to strengthen against a foreign currency it trades against then you will get paid back in a less valuable currency. You could lose some of your investment and purchasing power.
There are some positives, the rise in rates is not very likely to cause a spike in defaults. Even though municipals are in a vulnerable state, for example Detroit filing bankruptcy, corporations are in better shape and can withstand a tightened monetary environment for a good period of time. Those who love to trade the dollar will be happier as well. Rising yields mean a stronger buck.
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