Interest Rate Projections: As Interest Rates Rise, Current Bull Market May Falter

This article was written by Blair Goldenberg, a Financial Analyst at I Know First, and enrolled in a Masters of Finance at Colorado State University.

Interest Rate Projections

Summary

  • Current Bullish Outlook on 10-year Treasury Notes
  • I Know First Algorithm Bullish Forecast For US 10Y

Current Bullish Outlook on 10-year Treasury Notes

A 10-year treasury note is a debt obligation issued by the United States government that matures in 10 years. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity. An advantage of investing in 10-year Treasury notes, and other federal government securities, is that the interest payments are exempt from state and local income tax. However, they are still taxable at the federal level.

The U.S. Treasury also sells notes with two, three, five and seven-year terms. All of these notes, along with Treasury bills and notes, can be purchased directly from the U.S. government through the TreasuryDirect website via competitive or noncompetitive bidding with a minimum purchase of $100 and in $100 increments. They can also be purchased indirectly through a bank or broker. Investors can choose to hold Treasury notes until maturity or sell early. There is no minimum ownership term Retrieved from Investopedia.

Last week, the 10-year Treasury yield reached 2.60%, and closed at 2.54% on Monday. Jonathan Krinsky, a chief market technician at MKM Partners, noticed a pattern indicating a bullish yield on the 10-year Treasury Note. Bullish returns on the note haven’t been noted for at least 35 years. In the last six months, the 10-year Treasury rate showed returns of 1% which indicates a bull market.

“Earlier this year, 10-year yields traded below the low of last year (1.64%), and are currently above last year’s high (2.50%). Should they close above 2.50% [this year], it would represent a bullish outside year for yields. Since yields peaked in 1981, that has never happened,” says Krinsky Retrieved from Market Watch.

Interest Rate Projections

Long-term notes, such as the 10-year Treasury Note, haven’t entirely recovered since the financial crisis in 2008. The recovery has been slow due to subdued inflation and easing up of the Federal Reserve. The chart above shows the movement of the 10-year Note since 1960. The current rate is less than the 10-year note from the early 60s in the United States. The rate increase is long over-do. In the 1980s, the rate peaked at 15% but has continually declined since, as shown by the chart. Though the rise is over-do, yields are inverse to increase in rates on notes. And as such, Jeffrey Gundlach, the “Bond King” on Wall Street, says that if the rate moves past 3%, it will harm the current rally on the stock market as well as the housing market because it will cause mortgage rates to rise. This will then deter people from buying real estate. Opportunity costs will also rise which will make investors want to keep their money in banks rather than interest-bearing assets.

Markets have anticipated the upwards movement of interest-rates, as futures predicted the increase with a probability of 100%. The effect will be a minimal increase in borrowing costs for consumers and companies. Employment will also be effected by the interest-rate hike with the central releasing a statement that the labor market ‘”has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year…Job gains have been “solid,” consumer spending is “rising moderately” and business investment “has remained soft,” the Fed said” Retrieved from Bloomberg Markets.Unemployment has been at a 9-year low, falling back to 4.6%. However the Fed’s projections on economic growth, employment and inflation seem to be rising very slowly in the next three years.

Even with all of the risks to the market, the economy is very close to the Fed’s goal as unemployment continues to fall and 180,000 being created monthly. Inflation is also nearing the Fed’s goal of 2%, the preferred index of consumer prices from the Central Bank is up to 1.4% and core inflation is up to 1.7%.

The Central Bank increases interest rates in order to keep these figures in check. If they don’t raise interest rates, inflation will ultimately rise above their goal of 2%. This doesn’t help the stock market as Gundlach has said, it actually ends up hurting it, but it’s an important aspect of our economy. Interest rates are further projected to rise throughout the upcoming year, possibly up to 3 times more than the rate currently.

I Know First Algorithm Bullish Forecast For US 10Y

I Know First currently maintains a bullish stance on US 10Y with signal strength 44.88 and predictability 0.58 for 1 year forecast.

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I Know First was bullish on US 10Y in the past. This bullish forecast for US 10Y was sent to the current  I Know First subscribers on December 13, 2016 where US 10Y had a signal of 16.58 and a predictability of 0.11. US 10Y reached 4.93% in returns.

I Know First Algorithm Heatmap Explanation

The sign of the signal tells in which direction the asset price is expected to go (positive = to go up = Long, negative = to drop = Short position), the signal strength is related to the magnitude of the expected return and is used for ranking purposes of the investment opportunities.

Predictability is the actual fitness function being optimized every day, and can be simplified explained as the correlation based quality measure of the signal. This is a unique indicator of the I Know First algorithm, allowing the user to separate and focus on the most predictable assets according to the algorithm. Ranging between -1 and 1, one should focus on predictability levels significantly above 0 in order to fill confident about/trust the signal.

Conclusion

Though interest rates are rising, and it seems that the economy will be negatively affected, it is important to remember that the hike is combatting inflation. If the Central Bank doesn’t raise interest rates, inflation could skyrocket which would be even worse for the economy in the United States.