And They Called It Puppy Love

The markets are infatuated with the prospect of stronger U.S. economic growth, and are ready to believe in higher inflation and interest rates as suggested by the pro-growth agenda of President-elect Donald Trump. Since the election, the stock market has rallied and interest rates have risen sharply. 
Infatuation and puppy love are certainly strong emotions, and it is easy to get caught up in the whirlwind. Yet few of these first crushes survive into adulthood, and not all pro-growth agendas are as successful as hoped. 

We have seen infatuation wane over the last few weeks as interest rates retreated from their highs and as investors’ emotions were subdued by rational thinking. GDP growth is hard to produce in an economy where the birth rate is low, the baby boomers are retiring, immigration is discouraged and where productivity gains are at the low end of the historical range. Add in the potential for trade protectionism and the math doesn’t totally work, in our opinion. Longer-term interest rates are held in line by a strong dollar that serves to depress the price of imports, wage growth that is still not robust and central banks around the world that are doing their best to keep rates at rock bottom levels. The low rates in Japan and Europe will help keep our rates in check. Finally, jobs will be hard to bring back to the rust belt when most were lost to automation. The luddites were not successful, and we will not recover the majority of our industrial manufacturing jobs. Strong-arming companies to retain or create on-shore jobs will help a few workers and score political points, but the tide will not be turned.

Ten Year Treasury Rate – Last Five Years

 

Could rates tick up in 2017? Sure. The Federal Reserve has kept the Fed funds rate close to zero since 2009, and it is well past time for normalization. The Fed very cautiously started the process in late 2015, then followed up late last year with another rate hike, and most think there could be two rate hikes this year. This pace is very, very cautious. In 2007 the Fed funds rate was 5.25%. 

So, will the bond market enter a sustained bear market where yields move sharply to the upside? Economic data would suggest no. However, seeing a little more income in bank accounts and bond portfolios is a good thing for savers and investors who have been starved for yield for way too long. In this time of infatuation and policy uncertainty, we believe we can add value through prudent credit selection and smart, tactical sector allocation, which allows us to maximize yields while minimizing risk. Fixed income investing is all about income, after all.

Source: Bloomberg, Wall Street Journal, Financial Times