Investing Advice: Buckle Up for Turbulence
By: Steve Smith
Summary
Of the three possible scenarios, rates meandering is the least likely.
The historical interest rate events discussed above offer hints that allow investors to better assess the possibility of each scenario but, unfortunately, with unusually poor clarity. The reason is our starting point on this occasion is without historical precedence. We are at the lowest levels of interest rates in the history of mankind and the highest amount of leverage. To make matters worse, central banks don’t understand the effects of their recent interventions.
The economy has just received a large fiscal boost via the tax cut and new budget agreement which will be accompanied by large deficits for years to come. The growth impulse over the next several quarters will be meaningful, but there are a variety of offsets. First, the Fed is hiking rates and removing unconventional stimulus (QE).
Second, tariffs intended to level the trade paying field hold an uncertain outcome but run the risk of stoking both inflation and the ire of foreign trading partners. Geopolitical risks remain elevated, and those come with the small but real threat of an exogenous shock to the economy. Synchronous global growth appears to be forming, but recent data from China and Europe imply economic deceleration. Uncertainties remain quite high and are not being accounted for in the price of risky assets.
The one sure thing I would bet on for the remainder of 2018 is more volatility in every asset class, including interest rates. As a direct input into the pricing of all financial securities, higher volatility tends to imply lower stock prices and wider credit spreads on high-yield debt. As such, bond and stock investors should equip themselves to deal with volatile markets. The reprieve of the moment is a gift and should humbly be viewed as such.
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