Did you ever wonder why mortgage rates have been so low this year? Well, let me take you on a journey. Mortgage rates are influenced by government bond interest rates. Government bond interest rates are influenced by the price of Government bonds. If bond prices go up, then interest rates go down. In order to raise the money to pay for all of the irresponsible spending of the Government, the Treasury sells Government Bonds. Institutions, other countries, investment firms, etc. buy the bonds from the Government. That money then goes to work to pay for all of the spending created by the Government.
The Government has a lot riding on those government bond sales or auctions. If they go well, the Government sells the bonds and gets the money, bond prices go up, and interest rates stay low. Since most people don’t want to lend the US money because we are in so much debt as it is, someone had to step in and help buy those bonds. Yes, the Federal Reserve Board has been buying bonds all year creating more debt and keeping bond prices higher and interest rates lower. I will not even go into how incredibly irresponsible it is for the US to buy its own bonds. That goes without saying – the problem is that program is coming to a grinding halt at the end of this week following the largest bond auction on record this week – 123 billion dollars worth of government bonds to be issued. The Fed will get out of the way and the bond markets will be allowed to function freely again. That might not be so good.
Interest rates started going up today and are at a 2 month high. What happens when you suppress something that should be going up and then stop? It is like compressing a spring. If you let go of the spring, it takes off. I think that the same thing could happen with interest rates. If this happens it could disrupt the credit markets, consumer interest rates will go up, businesses will have even more trouble borrowing money, and homeowners will now have trouble getting low cost mortgages.
The stock market would have a tough time with raising rates. However, the rising interest rates should help the dollar. If the dollar is going up, the price of gold should take a hit. Welcome to Deflation! The economy might start the debt detox process that should have started when this crisis started.
If you are looking for a catalyst, this could be it. Interest rate risk is not something that the stock market is ready to face. However, China and others would certainly like to see the value of our dollar go back up.
If what you describes occurs, what do you think TIPS will do? I know bond prices typically go down when interest rates rise, but as I understand what you said, interest rates will rise but deflation will result, so it seems no place including TIPS is safe?
A deflationary recession is a tough one on investors. If the analysis is correct, it could resemble much like last year when bonds and stocks fell at the same time. In deflation, all assets fall. So that doesn’t mean that there are no opportunities to make money. It means that buying and holding in anything can be a bad idea. The key is having an investment strategy where you utilize alternative investments and you are strategic with your investments. The good news is that we will have some great buying opportunities. The key is having an exit strategy.