In an August 26 Barchart article, I highlighted the decline in the U.S. bond market that pushed interest rates dramatically higher over the past years. In that piece, I highlighted the decrease in the TLT ETF, that rates would likely stabilize without moving much higher, that U.S. debt makes government bonds unattractive, and that geopolitics will keep inflation above the Fed’s 2% target level. I concluded that “Rates may stabilize, but the odds of any return to the pre-March 2022 environment are slim to none.”
U.S. long bonds are sitting near the lows
The U.S. 30-year Treasury bond futures contract reflects interest rates and the demand for U.S. government debt securities at the long end of the yield curve.
The twenty-year chart highlights at 119-07 on September 13; the long bond futures were near the lows and just above the 117-18 August 2023 low, the lowest level since February 2011.
The bearish trend in the futures began in March 2020 and continues in September 2023.
TLT is marginally higher than the August 2023 low- Support at the October 2022 bottom
The iShares 20+ Year Treasury Bond ETF (TLT) is a highly liquid product with over $40 billion in assets under management. TLT trades an average of nearly 23.5 million shares daily and charges a 0.15% management fee.
The chart illustrates TLT’s latest October 2022 $91.85 bottom, an eleven-year low. At below $94 on
September 13, TLT was near last year’s low, at the lowest level in 2023, and in a bearish trend.
Inflation indicators are improving, but 2% is unrealistic
Over the past months, U.S. inflation, which had risen to a four-decade high, cooled. Consumer and producer price data declined but remained over double the Fed’s 2% target level.
While core CPI and PPI exclude “volatile” food and energy prices, energy is a critical component of goods and services costs. Since May 2023, crude oil prices have been rallying. After falling below $70 per barrel earlier this year, Brent futures moved over the $90 level, and NYMEX WTI futures are approaching that milestone. Rising traditional energy prices fuel inflationary pressures. The latest August CPI data showed the economic condition moved higher last month.
While the Fed continues to state it will remain hawkish until inflation falls to the central bank’s 2% target level, the goal could be unrealistic without pushing the U.S. economy off the edge of a recessionary cliff. Markets reflect the economic and geopolitical landscapes. While the Fed can influence the economy through its demand side, geopolitics is another story. Rising oil prices are a function of U.S. energy policy and OPEC+’s increasing control of international supplies. Rising energy prices that fuel inflation could make the Fed’s target unreasonable.
Markets are digesting the higher rate environment
While the Fed may remain on its hawkish monetary policy path, the odds of more than two more 25-basis point rate hikes in 2023 are slim. As of September 13, the Fed Funds Rate stands at 5.375% after rising from zero percent in March 2022. A move to 5.875% is less dramatic than the trajectory of the increases since liftoff from zero percent short-term rates. While higher rates will weigh on economic growth, markets have digested the higher rates. Considering the hawkish monetary policy, the most diversified U.S. stock market index, the S&P 500, has done pretty well in 2023.
The chart shows the S&P 500 rose over 16% from 3,839.50 on December 30, 2022, to 4,470 on September 13, 2023. Rising interest rates tend to be bearish for stocks as higher yields attract capital from equities to fixed-income assets. However, stocks have posted double-digit gains in 2023 despite the decline and bearish trend in the bond market.
Rates were too low in 2020 and 2021- They may be just right in 2023
Interest rates were far too low in 2020 and 2021. In hindsight, which is always twenty-twenty, the zero-interest rate environment and quantitative easing planted the inflationary seeds that pushed the economic condition to the highest level since the early 1980s.
Interest rates could be at just the right level, between 5% and 6% in 2023, as they have not crushed the stock market. Time will tell if the Fed pauses and allows the rate hikes to filter through the economy over the coming months or if they increase another 25 or 50 basis points before the end of this year.
I expect the bearish trend in bonds to stabilize. While a lower low is possible, I believe it would be marginal, and bonds will find a comfortable range around the current level. Meanwhile, issues that may derail stability in the bond market are a geopolitical event or significant U.S. credit downgrade that causes other governments to liquidate their U.S. government debt securities holdings. A flight-to-quality could cause a rally. However, I favor stability over the coming months as the trajectory of rate increases slows.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
