Have Interest Rates Peaked?

Well Morgan Stanley sure seems to think so:

The benchmark 10-year Treasury note yield has peaked for 2018 as trade worries, weaker emerging markets and a strong dollar cap the prior move upward in rates, according to Morgan Stanley.

“We started to take note of a changing dynamic for global government bond markets in late April and early May,” the firm's global head of interest rate strategy, Matthew Hornbach, said in a note to clients Friday. “Not only do we think these factors will continue for a while longer, but we also think other factors will drive government bond yields lower.”

“That's right, 3.12 percent was it,” he added, referring to the 2018 peak in the 10-year Treasury yield hit in mid-May. The 10-year yield has fallen sharply since then, last seen under 2.9 percent as a renewed wave of trade tensions gripped markets and threatened to stall global economic growth. Yields fall as prices rise.

A quick glance at a chart of the 10 year yield shows that Morgan Stanley has access to the data and has successfully identified the current trend. The rest of their analysis is little more than an assumption that past is prologue. I'd also point out that whether they know it or not, they are saying that growth has peaked. I’m not sure that qualifies as analysis but I guess it is as good as any other crystal ball gazing.

Here’s an alternative scenario which has just as much chance of being correct as Morgan Stanley’s:

President Trump, facing an election in November and soybean prices in the toilet, takes the concessions that China has already offered, adds a big farm products purchase order from China and declares victory. Tariffs are canceled and trade fades as a major issue.

With the threat of tariffs gone, the dollar resumes its downtrend, raising commodity prices – particularly oil – and inflation fears with it. The 10 year Treasury yield breaks decisively above 3% and finally tops at 3.25% as the Fed hikes rates twice more this year. The yield curve flattens further to just 20 basis points; the economy continues to grow but at the long term trend of around 2%. 

Emerging markets, meanwhile, benefit from the weaker dollar and higher commodity prices. EM stock and bond funds both see large inflows and outperform all developed markets.

I have no idea if any of that is likely - it's just a WAG - but it is every bit as plausible as Morgan Stanley’s scenario. Luckily you don't have to invest on the basis of my guess or Morgan Stanley's. In fact, you don’t have to predict the future to be a good investor. A purely passive approach doesn’t require any foresight at all, just a strategic plan and the ability – financial and emotional – to stick with it.

Even an active approach doesn’t really require you to predict the future. Momentum within and across asset classes is a perfectly reasonable approach with ample research available to help you identify and implement a specific strategy. Just like with the passive approach though, you need to stick to it. There is no investment strategy or tactic that will work 100% of the time; for it to pay off you have to keep doing it even when it isn’t working.

Don’t waste your time trying to do the impossible. It isn’t necessary and may actually be harmful if your predictions – or Morgan Stanley’s – don’t come true.