By John Pangere, editor, Strategic Investor
At Casey Research, we believe in getting the big picture right.
That’s why every December, we make predictions for different key markets and economic indicators for the coming year.
We don’t care about the exact price. Instead, we want to determine the direction of the move: higher or lower.
So far in our series, we have covered the future trajectory of inflation and the U.S. dollar.
And now, we will delve into a much-anticipated topic: interest rates.
After seven rate hikes this year, with four equaling 0.75 percentage points, it’s important to examine what we forecast last year… and what we see happening for the next.
Because now, more than ever, is the time to stay away from trouble.
Right on the Money
For the past two years, we predicted that interest rates would rise. We measured this by tracking the benchmark 10-year treasury yield.
Again, we nailed the move. As we write, the 10-year yield is up 2.5 times from its level just a year ago.
Last year, we said it seemed counterintuitive to predict a higher rate given the multi-trillion-dollar government spending spree over the past few years.
As we’ve written many times in these pages, it doesn’t matter who’s in power. When you hand someone the purse strings with almost no consequences, they’ll spend like a drunken sailor at last call.
For long-time readers, we’ve said for years the U.S. government debt just about doubles under each two-term president. (Or every eight years.)
Under Reagan, the debt grew 185%. Under George W. Bush, it grew 93%. Under Obama, it grew 78%. George H.W. Bush and Clinton together sent it up 111% over a combined 12 years.
With Trump, the debt spiked $7.2 trillion in four years. That’s a 36% increase.
In two years with Biden, nothing is much different. The debt is up over 10%. Combined with Trump, it’s up 53% in six years. Which says it won’t take much for it to double again over an eight-year period.
What enabled a lot of this spending to explode higher are two things: Nixon closing the gold window in 1971 and cheap money. By cheap money, we mean the U.S. Treasury borrowing at low rates for decades, due in part to the policies of the Fed.
Now, in some circles, the Fed raising the overnight lending rate means the game is over. But we don’t think that’s the case.
As we showed you above, spending happens at all times under all administrations.
Which means that eventually, the Fed will capitulate. It has to… or it’ll risk the U.S. defaulting on its debt as the interest on that debt skyrockets.
There Are More Rate Hikes Ahead
However, we don’t think that will be the case in the short term.
In fact, in October, I (John Pangere) attended the Bloomberg Invest conference in New York. I had the chance to be in the room with some of the world’s top investors.
That includes Kenneth Tropin.
Ken Tropin discussing macro investing
Ken Tropin discussing macro investing
He’s a global macro investor along the same lines as Paul Tudor Jones, one of the greatest traders of all time.
For those of you unfamiliar, global macro investing is all about things like currencies, interest rates, and commodities. It’s an alternative to equity investing.
Tropin’s Graham Capital Management has about $19 billion in assets. But more importantly, his investing career spans over 40 years. He’s seen it all, including starting Graham Capital in 1994, so he knows how to navigate nearly any type of market.
That’s still true today. At the time of the Bloomberg conference, his fund was up around 50%. And he said it’s all due to the current global macro environment.
During his talk, Tropin explained that what drives global macro performance is central bank movement. That equates to volatility in the markets he trades.
For instance, Tropin said in the period between 2010 and 2021, the ECB, Bank of England, and the Fed hiked rates only 13 times on a level of 25 basis points or more. That’s in stark contrast to today, where we’ve seen over 25 rate hikes alone of that size or greater collectively among those three institutions.
It’s part of why he expects the current market to last longer than anyone really expects. In fact, he thinks over the next several years, it’s going to be a bonanza for global macro investors…
However, it was his talk surrounding the Fed that caught our attention. He’s skeptical the Fed will be able to ease interest rates by the end of 2023. It’s in part due to persistent inflation that’s far above the 2% benchmark.
For the most part, we agree. There may not be much more to go before the Fed backs off. But like Tropin, we think there are more rate hikes ahead.
That tells us to expect more of the same for interest rates in the year ahead.
We don’t think the move will be nearly the same as in the past year. But since the Fed is raising short-term rates to fight inflation, this will continue to put upward pressure on long-term rates like the benchmark 10-year U.S. Treasury bond.
Now, the Fed can control its overnight lending rate. It can’t control longer-term rates unless it starts a full-blown yield curve control (YCC) program.
YCC is when the Fed targets a set rate for different maturities of debt – like the 5-year or 10-year bonds – and buys enough bonds to hit that rate.
The last time this happened was during World War II. In April 1942, the Fed capped yields of short- and long-term bonds to help keep borrowing costs low. The more debt the country demanded, the more bonds the Fed bought.
After the war, the Fed wanted to reverse course despite objections from President Harry Truman. Finally, in 1947 with inflation raging at 17%, the Fed ended rate caps.
While we’re not in a major war today – at least not yet – if we see YCC in the near future, all bets are off. The market will have no say in what happens at that point.
We wouldn’t rule that out for the future, but it may be some time before that happens.
Editor, Strategic Investor
P.S. That’s a wrap for part I of our prediction series. Next week, we’ll cover gold and oil, the stock market, real estate, and bitcoin. So make sure you tune in.