Will rising long-term interest rates impale your future? A poll of financial professionals shows they think rates will keep rising, believing the Federal Reserve’s hikes will push long-rates up. But that isn’t how it works.
I learned very young that any forecast that professionals agree on is exactly what is already prepriced into markets.
The good news is that bond rates will remain tame. The bad news? Don’t hope for high bond returns anytime soon. Whether mortgage rates, corporate bonds or tax-free municipals, they all wiggle based off gyrations in the 10-Year U.S. Treasury rate. And, yes, those rose almost a half-percent this year to 2.96% (peaking May 15 at 3.12%). That’s about all she wrote. They’re now around the level of Feb. 21. Plum out of steam.
My May 6 column briefly touched on what mostly drives long rates: variations in inflation expectations. Most pundits misunderstand inflation — thinking it comes from low unemployment and rising wages. No! My November 5 column explained it comes from fast-rising money supply. Too much money chasing too few goods and services. If the broad quantity of money doesn’t grow far faster than our economy, we don’t get intensifying inflation — or long rates.
First consider the “real” rate — what lenders require to be “compensated” for forgoing cash long term, except for inflation’s effect. It hardly wiggles, except in a crisis, and approximates GDP’s “real” growth rate (roughly 2.5%). There is also an “inflation premium” on top of that real rate, which is the extra needed to compensate lenders’ collective future inflation fears. That portion wiggles wildly as inflation expectations gyrate. It’s most of the variation in the combined rate. Without real escalating inflation, which requires excess money growth, inflation expectations can’t wiggle too far.
To see if money supply is jumping or slumping, first note what money is. Paper and coins, of course — but much more. Bank deposits, short-term commercial loans, Treasury bills, money-market accounts — everything of stable value, broadly exchanged and liquidated easily, fast. It’s officially called “M4”, the broadest money measure. M4 grew 4.6% in the year through April, slower than most of 2016 — when inflation flat-lined.
M4 is overwhelmingly created solely via bank lending — when the banking system increases net outstanding loans. Zooming M4 requires booming bank lending.
Here is the trick. Banks use short-term deposits as the foundation to finance long-term loans. The amount long-term rates exceed short-term rates determines future banking profitability from lending — their profit spread and basic motivation to lend. The bigger that spread, the more they lend. And vice versa. When our Federal Reserve raises short-term rates, like now, it shrinks that profitability. So bank lending slows, M4 growth slows and inflation slows. And long rates bounce around — going nowhere fast.
The more short rates are hiked, the more long rates won’t rise, or may actually fall. Of course, it’s a global world. What matters most is global money supply, inflation expectations and long to short rate spreads. But global rate spreads have fallen slightly since last year. Hence global lending and money supply have grown modestly. America’s M4 growth likely parallels that global reality. So there’s no escalating inflation.
Folks are whacky wrong worldwide on long-rates regularly. Read hysterical stories on Italy’s political gyrations and supposedly catastrophic debt. But it works there like everywhere, basically. If Italy’s debt were truly problematic, wouldn’t its 10-year yields be miles above ours? But as I write, they’re basically identical to America’s. Why? Modest money growth. Same saga. And, as I detailed last week in Il Sole 24 Ore, Italy’s top business paper, the country's debt is in its best shape in decades — and manageable.
Still, when Italy can borrow as cheaply as America, the world must be in vastly better shape than rate-doomers deduce. And fear of a false factor is always bullish. Fears don’t get much more false than today’s rising-rate phobia.
Ken Fisher is the founder and executive chairman of Fisher Investments, author of 11 books, four of which were "New York Times" bestsellers, and is No. 200 on the Forbes 400 list of richest Americans. Follow him on Twitter @KennethLFisher
The views and opinions expressed in this column are the author’s and do not necessarily reflect those of USA TODAY.