Interest rates

Fisher: The Many Myths Behind Worries About Rising Global Interest Rates

Are global interest rates destined to skyrocket in 2022? As inflation rises in many Western economies, the ECB, Federal Reserve and other central banks appear poised to “tighten” monetary policy. Thus, the recent rise in long rates could look set to skyrocket. Many observers, pundits, economists and investors worry about major economic and trade fallout if they do. If this were true, China would suffer from a drop in export demand. But don’t sweat on it. As temporary price pressures ease, long rates will shock everyone and end 2022 where they started – whether central banks “tighten” or not. And even if yields increase, the impact will not match the fear.

While the headlines talk about lasting inflation, the still benign long rates show that the forces currently driving prices are temporary. If they weren’t, long rates, which reflect inflation expectations, would surely have risen a long time ago. Yes, outside of China’s sideways drift, rates have rebounded higher in most major countries. But consider the levels. In the United States, 10-year Treasury bond rates went from a meager 1.51% at the end of the year to a still derisory 1.75%. German prices? They went from -0.18% to -0.03%, which many fear is “almost positive”. French yields fell from a miniscule 0.20% to 0.30%. Japanese yields have more than doubled! But you need a microscope to see the 0.07% to 0.15% increase.

Why haven’t yields jumped? Markets see what the narratives miss: To be sure, sustained inflation is widespread. It is, as Nobel laureate Milton Friedman taught, a monetary phenomenon – too much money for too few goods. The recent high inflation in most of the world is different. Beyond the energy crisis, this involves supply chain issues, a function of intermittent lockdowns and reopenings around the world aimed at stifling the spread of Covid. Despite temporary and renewed lockdowns like those in Xi’an, these problems are already easing. Container shipping prices are down sharply from last year’s highs. It is true that the consumer price index for the euro zone rose by 5.0% over one year. But basic prices, which exclude food and fuel, rose a much slower 2.6%. U.S. core prices, at 5.5% yoy, are also below the headline rate of 7% – and services prices are even slower, as they are relatively immune to supply chain pressures. ‘supply. January surveys of purchasing managers showed that prices have largely cooled in Europe and the United States as well, as inventories recover.

The ECB and Fed reductions in long-term bond purchases as part of quantitative easing (QE) will not boost long rates either. Now, QE has pushed down long rates. Bond prices and yields move in opposite directions. Extensive buying from central banks pushed prices up and long-term yields down. But remember: markets price all well-known information in advance – and the upcoming end of QE is old news. Central bankers have telegraphed a gradual reduction for months. Thus, US 10-year yields fell 0.04% between the Fed’s tapering in November and the end of the year, despite policymakers’ tapering accelerating in December. In Europe, the 10-year German Bund yield fell immediately after the ECB’s QE cut in September. Ditto for French yields. Markets anticipated the QE cut a long time ago, then moved on. If less QE hasn’t already improved returns, why would it now?

Many dismiss this, however, and argue that the impending short-term rate hikes by the Fed, ECB and Bank of England in 2022 will cause long rates to skyrocket. No. Consider the United States for its long history of data. Since 1933, the median increases in the 10-year Treasury yield that have occurred 6, 12, and 18 months after the initial Fed hikes are 0.14%, 0.25%, and 0.18%, respectively – tiny ! Ten-year yields have fallen by about a third of these historical durations. And, now, no one seems to have noticed it, so it has positive surprise power.

Why don’t long rates reflect short-term yield movements? It’s simple: long rates are set by the market and change according to inflation expectations. Short-term rate hikes controlled by the central bank are aimed at slowing inflation. Markets anticipate and pre-price widely watched factors like central bank decisions. Always.

Outside of China, global yields tend to move in parallel. Over the past 15 years, the correlation between US and Chinese 10-year yields is only 0.15, which is not significant because 1.00 means identical movement and -1.00 exactly the opposite. This is likely due to the fact that China’s capital movement reforms are relatively new and nascent. But UK gilts have a correlation of 0.73 with US yields. German and French rates have correlations of 0.66 and 0.62 with US rates. Even Japanese yields have a correlation of 0.51 with US Treasuries. So if you accept that US yields are unlikely to rise materially in 2022 – and may be more likely to fall – know that this extends to much of the world.

What if I’m wrong and US and global yields go up? Do not be afraid. Rising rates do not pose an economic threat to the United States, the world or China. Since China joined the World Trade Organization in 2001, US long-term interest rates have seen some persistent increases. For example, from May 2003 to June 2006, 10-year yields rose from 3.37% to 5.14% (while the Fed raised short-term rates from 1% to 5.25%, which proves once again that long returns are not parallel to short ones). During this period, the quarterly GDP of the United States posted an average annualized growth of 3.6%. US imports from China rose an average of 23.6% year over year. The Chinese economy, as you know, has grown by leaps and bounds.

US 10-year yields rose again from July 2012 to December 2013, more than doubling from 1.47% to 2.97%. US GDP grew every quarter during this period, albeit at a historically slow average rate of 1.9%, which still created increased demand for Chinese products. Over these six quarters, China’s GDP growth averaged 7.7% year-on-year. U.S. imports from China grew an average of 4.1% year-over-year, in line with generally sluggish U.S. economic growth and China’s shift away from commodity-led growth. exports to domestic consumption.

When it comes to equities, many in the West have long claimed that rising rates are poison. An old mythology – “don’t fight the Fed” – warns investors to stay away from equities when rates rise. But that’s bullshit. In the United States, the correlation of the S&P 500 with 10-year yields is slightly positive — 0.33. The German 10-year and the DAX? Also 0.33. In France, the correlation of the CAC 40 with 10-year yields is 0.15, while equities and Chinese yields have a tiny correlation of 0.16. Modestly positive correlations reveal no established relationship between long rates and equities – nothing to guide portfolio decisions. They certainly don’t support the theory that rising rates kill equities.

Fed rate hikes aren’t sinking stocks either. The Fed has launched 10 cycles of rate hikes since 1971. In the 12 months since each one’s first hike, U.S. stocks have averaged gains of 6.9%. They increased after 8 of the first 10 hikes. Similarly, 24 months after the first rally, US stocks have averaged 19.3% and are up 80% of the time. That doesn’t mean you should completely ignore central banks. When they get it wrong, it can cause big fallout. But most of the time they just react to conditions – they don’t create them. Rate hike cycles normally start because the Fed reacts to a growing economy increasing inflationary pressures, so it sees less need for “stimulus”.

So don’t let the rate hike goblins scare you off in 2022. For one thing, the rate hike is unlikely to materialize. But even if they do, it won’t be bad for stocks, China’s growing economy, or the world’s.

Ken Fisher is the founder and executive chairman of Fisher Investments.

The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.

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