Have We Entered A Period Of Higher Long Term Interest Rates and Rampant Inflation?
I am Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, and the question on many investors minds right now is how high will long term interest rates rise and when will they stop moving higher? Their question is, Are we there yet?
Does the investment team at Oak Harvest subscribe to the theory that we have entered a multiyear period of higher long term interest rates and rampant inflation like the 1970’s? A period when both interest rates and inflation ran in the double digits?
I’ll let you know shortly but Give us a call at(877) 896-0040 and give our investment team a chance to help you with your long term investment allocation, and give one of our financial planning teams a chance to model your cash needs and greed’s into and through your retirement years. Whether your cash account is yielding a few basis points or a few percentage points, or whether the 10-year Treasury rate is 50 basis points or 2%, the entire Oak Harvest team is here to help you navigate your journey into and through your retirement years.
So, the question is are we there yet? Are we there yet on yields? Have long term interest rates peaked?
Many investors and the financial news channels are currently panicked about high inflation and a weak labor supply. These two dynamics have both pulled forward and heightened forecasts for central banks to increase short term interest rates. Currently, the consensus path has jumped from maybe 1 rate hike in late 2022 to 5 or more over the next 12 months.
We view these higher estimates as unlikely as tough comps and gravity are likely to become increasing headwinds throughout the second and third quarters of 2022.
Both Inflation and growth will face huge battles in 2022 against lapping the peak in government fiscal spending and add-on covid benefits from mid-2021. Moreover, at the bank level, because of the mid-2021 Delta wave, global credit creation started slowing in 2nd half 2021 and this usually leads a slowing of economic activity by 6 to 12 months.
Viewers recall that inflation is measured as a percentage change year over year. This means that even if prices are rising, it takes added energy and momentum for prices to extend at high rates for multiple annual periods. Things like shipping rates have rolled over dramatically the last 3 months. Other costs that are talked about a lot on TV are ones like energy costs, look to be peaking in their normal seasonal fashion as well. The pandemic demand and supply mismatch has caused a surge in global goods inflation however, this dynamic appears maxed out and inflecting lower. Things like Semiconductor supply and demand are beginning to move back into balance.
As our economy reopens from the recent slowdown and hit we have taken due to the Omicron wave, many companies will likely see a better labor supply picture. They will be better able to fill their hiring needs. This is at the same time they should see a reduction in one-time employee overtime and sick leave costs that hit them the last few months.
On the growth side, the economy is set to slow quickly over the coming quarters as almost 70% (4.9% of the 6.9%) of 4th quarter 2021 GDP growth was inventory restocking. Inventory restocking is just replenishing stocked out depleted inventory. Yes it does count in the numbers, its is generally NOT a sustainable or healthy dynamic over quarters or years. Think about all those extra Clorox wipes you have in your closet now. You probably won’t have to buy any of those for a couple of years.
The great goods demand surge in the US has passed and, in time, goods inflation should follow. Much of the goods demand surge was tied to government fiscal transfers while supply chains were constrained by Covid. I bet all of you viewers who wanted to order that Peloton in the 4quartter of 2020 for XMAS and couldn’t get it because there was a 3-month waiting list and back orders, are glad you canceled your order?
With most of these government assistance programs now past tense; goods spending is slowly returning to trend. This is just as small businesses are beginning to adjust their accumulation of inventory downward. Here is a chart of US durable goods spending. One can see its collapse during Covid and its almost symmetric impulse higher as the economy reopened. Net net? We are now slowing and heading back to our long term growth trend.
Even if we are off in our assessment of the upcoming inflation numbers, it looks like the markets have already rushed to near an “end-game” result for the Fed tightening this year. In other words, it should be very hard for the Fed to cause more hawkish surprises over the next 2 quarters. Here are a couple of interest rate charts to give you a visual of what we are seeing in real time. As we have pointed out for months now, the markets expectations are that we have passed peak inflation and we are heading down the other side of the slope. Will it return to sub 2%? I doubt it. Our team believes we reached the secular lows in both interest rates and inflation back in 2nd quarter 2020.
So, to answer the question? Are we there yet on long term rates? For 2022? It looks to our team like we have already factored a lot of the hawkish Fed action into the bond markets for the second and third quarters. Can 10-year treasury rates finish the year closer to 2.25 to 2.35%? Which is another quarter percent or 40 basis points higher? Yes, that has been our teams expectation for quite some time. Is that a death sentence for equities and the economy? We don’t think so. This would just get interest rates back to their average level since the great financial crisis hit in 2008.
The good news is that when the markets adjustment to the Fed is over, company earnings, stock buybacks, equity flows, investor positioning, and easier comps are likely to be good set up for a late second half 2022 and 2023 continuation of this bull market.
With the continued volatility that we expect, our investment team recommends that you get on the phone and give our Oak Harvest team a call and ask to speak to one of our financial advisors and planners. Set up a meeting and sit down with one of our team and let us walk you through how sequence of returns can affect your retirement plan every bit or more than the average investment return your current advisor is generating you.
Give us a call at (877) 896-0040 and give our team a chance to help you into and through your retirement years.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.