Will interest rates really jump in 2022? Inflation surges. The Fed and most central banks seem soon to “tighten.” Recent rising long-term rates have nearly everyone convinced much higher rates loom. Further, most think stocks’ January selloff—especially growth stocks’--portend a steeper swoon. Don’t believe it! As supply chain pressures wane, long rates will shock everyone--ending 2022 roughly unchanged—whether central banks tighten or not. If I’m wrong? The impact on stocks won’t match the fear.
Take inflation. In America it is increasingly a partisan issue in this mid-term year. But my comments aren’t ideological whatsoever; instead they simply assess the economics through a market-oriented lens. While headlines shriek of continuous inflation, relatively benign long rates show you the forces now stoking prices are temporary. Otherwise long rates—which reflect lenders’ inflation expectations—would have soared much more long ago. Lenders would have demanded it to compensate for any significant inflation risk eroding borrowers’ repayments.
Even after its recent bump, the US 10-year Treasury yields just 1.80%. That is meager, but juicy by developed world standards. The U.K. 10-year gilt offers only 1.14%. Japan’s nearly doubled since December—to a still-microscopic 0.13%. Germany’s recently made headlines … for briefly turning positive at 0.02%. Now? Negative again! Lending and money flows globally, seeking best returns. The correlation between long rate movements country to country is high and consistent.
Why haven’t yields jumped? Markets pre-price what pundits miss: True and enduring inflation is broad-based and monetary—too much money chasing too few goods, as Milton Friedman famously preached. Today is different. Beyond Europe’s energy crunch, current price pressures mostly involve supply-chain snags tied to varied global yet repeated and intermittent lockdowns and re-openings. Those pressures are temporary—and already abating.
Yes, US CPI rose 7.0% y/y in December. The eurozone’s climbed 5.0%. But month-over-month American inflation slowed in November and December. Eurozone spikes are largely limited to energy—core year-over-year inflation is just 2.6%. American purchasing manager surveys show input price jumps slowing to their lowest level since March--and Europe’s show leveling off. Shipping costs are down.
The Fed and ECB’s slowing quantitative easing (QE) bond purchases won’t jumpstart long rates, either. Markets pre-price all well-known information—and QE’s demise is staggeringly old news. Fed Chair Jerome Powell and ECB President Christine Lagarde telegraphed tapering for months. Hence America’s 10-year Treasury yield rose just 0.01 percentage point the week after the Fed’s November taper announcement and 0.02 point the week following its December taper acceleration. (It rose just 0.05% after Powell’s blunt talk this Wednesday.) The 10-year German bund yield crept just 0.03 point higher the week after the ECB’s September QE cut. Markets pre-priced it all long ago. If less QE hasn’t already juiced yields, why would it now?
But won’t widely expected short-term Fed rate hikes send long rates skyward? No! Long rates often rise slightly ahead of the first Fed hike in tightening cycles—because little is more widely watched and long pre-priced than central bank actions. But the Fed is much more reactor than causer, and usually the town fool—which I’ve preached for decades—meaning rises usually end there. Since 1933, the median 10-year US Treasury yield 6, 12 and 18 months after initial Fed hikes all gained less than a quarter of a percentage point—tiny! Long yields fell in about a third of those spans. Why? Again, long rates are market-set. Markets anticipate and pre-price widely watched factors like expected Fed moves. Always.
Note; The FED has never been good at forecasting. What do you get when you put 850 PhD Economists together? More or less the equivalent to the Russian Politburo. Apparatchiks all. Recall it was just months ago Powell claimed inflation was “transitory.” If you believe he was wrong then…..why be so sure he is right now. If you really want to scare yourself half stupid go back and look at Janet Yellen’s internal FED comments in October, 2008. More wrong than group think in a late night bar. And then unrepentant. Apparatchiks all.
Today most think rising long rates will hurt stocks overall—growth stocks and Tech especially. Early 2022’s volatility may appear to validate that. But too many other forces are entangled to pin the declines on interest rates. Markets are never univariate. Always remember, one liquid market never “knows” more than another—if looming rate rises drive today’s Tech sector stumbles, why haven’t long rates already surged?
History clearly shows rates alone don’t determine market direction—so be a contrarian. Consider: The S&P 500’s long-term correlation with 10-year yields is actually, and contrary to common mythology, slightly positive—0.33—showing a minor tendency for stocks to move with, not against, 10-year yields. Growth and Tech stocks are similar. Cognitive and confirmation biases likely make the consensus gasp at this thought. Regardless, that correlation is too weak to mean much—a trend mirrored globally. Germany’s 10-year bund and its benchmark DAX index have the same 0.33 correlation. Spain and Italy are negative, but even weaker. Flimsy, flip-flopping correlations reveal no set relationship between long rates and global stocks—nothing supporting doomsday narratives.
Still unconvinced? The Fed has launched 10 fed-funds rate hike cycles since 1971. In the 12 months after each initial hike, world stocks averaged 6.9% gains in USD, rising in 8 of 10 cycles. The two declines were only -3.9% and -13.6%, not great but no disaster. After 24 months, stocks averaged 19.3% gains, again with only two minor declines.
Now, don’t ignore central banks altogether. Sometimes they just do really stupid stuff. But they are more follower than causer—a force, but generally an overrated, after the fact one. Rate hike cycles normally begin when the Fed responds to economic growth fueling inflation pressures, so they see less need for alleged “stimulus.” And, in that they are right. We don’t need “stimulus” now.
Don’t let rising rate goblins scare you. Big time rising rates aren’t likely to materialize—but even if they do, they won’t wreck stocks or the economy.
