Despised Treasuries could be a good bet after Fed rate hike
Rarely has there been such unanimity of opinion among Federal Reserve officials and the cadre of analysts who track and attempt to predict their future moves.
Monetary policy will be tightened with a series of increases in the central bank’s federal funds rate target, plus an end to its large-scale securities purchases, then a reduction in its massive holdings of Treasuries and mortgage-backed securities, they say. The only disagreement among Fed watchers is how quickly the central bank will act to reverse its ultra-easy policy.
Indeed, there has been a kind of competition in forecasting the number of increases this year in the federal funds target, which is still in the low range of 0% to 0.25%, and the size of the widely expected take-off at the March 15 -16 meeting of the Federal Open Market Committee.
Last week, JP Morgan joined Bank of America and Goldman Sachs in predicting seven increases of 25 basis points, which would bring the target range to 1.75%-2% by December. (A basis point is equal to 1/100th of a percentage point.) A growing minority of observers are predicting a rare initial 50 basis point hike, to signal the Fed’s determination to counter inflation, which is reaching its highest high level for four decades.
Indeed, Credit Suisse investment strategist Zoltan Poszar, who is well versed in the money market, says a 50 basis point hike should be accompanied by a $50 billion sale of the Fed. This, Poszar writes in a client note, would drain liquidity, deliberately causing financial conditions to tighten in a way reminiscent of former Fed Chairman Paul Volcker, who broke the back of inflation in the early 1990s. 1980. Poszar posits that this would not only slow inflation, especially of rents, but also increase employment.
Reflecting on his childhood experience in post-communist Hungary, when generous transfer payments and early retirement benefits undermined labor market participation, he suggests that “the path to slower service inflation… . goes through falling asset prices.” A correction in stocks and other risky assets would lead some beneficiaries of their inflated prices back to work. “Young people feeling Bitcoin rich” and “old people feeling affluent” who retire early would return to the workforce, he argues provocatively. And, he argues, a correction won’t kill economic growth because 5% wage gains can easily offset higher mortgage payments.
“The decisions of central bankers are always redistributive. For decades, redistribution shifted from labor to capital. Maybe it’s time to go the other way then. What to brake? Wage growth? Or stock prices? What would Paul Volcker do? Poszar asks rhetorically.
Wall Street veteran Robert Kessler also sees Fed actions leading to a slowdown in the stock market. But rather than spruce up your resume, he recommends protecting past capital gains with a stake in the most unloved asset of all: long-term US Treasury bonds.
Until last year, Kessler was the longtime head of his eponymous investment firm, which served global institutions and ultra-wealthy individuals. Now retired, he divides his time between his homes in Denver – overseeing his art collection, some of which is on display in local museums – and Costa Rica, as well as the ultra-rich who moor their yachts of hundreds millions of dollars to escape the misfortunes of the world. He also manages his personal investments.
The very unanimity of the view that bond yields will continue to rise prompts Kessler to go against the consensus – a tactic familiar to him. In the decades he managed Treasury bill portfolios, they rarely had fans on Wall Street. He suspects the scorn reflects the fact that big brokers don’t do much peddling of US government notes and bonds, compared to what they earn from selling corporate debt and stocks or exotics. , such as derivatives.
Every market cycle of the past four decades has ended in a break in interest rates and a spike in bond prices, he points out, with each successive peak in yields lower than the last. For example, the benchmark 10-year Treasury yield was 6.5% before the bursting of the dotcom bubble in 2000. It had fallen to around 5.25% by the time the housing bubble began to burst in 2007. And it was as low as 3% in 2018, before the stock market had a near-bearish experience.
What’s different this time, Kessler continues, is the huge debt buildup on the financial system. Washington’s massive borrowing to combat the effects of the pandemic has pushed total marketable federal IOUs to $30 trillion. Relatively small increases in the cost of servicing that debt will dampen the economy, knocking interest rates down, he argues. He sees a situation similar to that appearing in Japan, with a heavily indebted economy leading to consistently low interest rates and inflation, and a stock market still about 30% below its late 1989 peak.
At the same time, this year marks the end of various fiscal supports provided by pandemic relief, Kessler notes. The much-quoted excess savings accumulation is concentrated among the top 1%, while the rest of America will face lower real incomes and higher prices. This is the scenario predicted here by the ancients Barrons Roundtable stalwart Felix Zulauf last December, who warned that the S&P 500 could plunge 38% in the first half of this year, to 3,000.
After Thursday’s 2.1% plunge, the large-cap benchmark was down 8.7% from its peak just after the start of the year. Kessler says typical investors with a stock-heavy 401(k) retirement plan should be sitting on big gains thanks to the S&P 500’s nearly 100% rally from its March 2020 lows. They should protect those profits, he adds, by investing a significant portion in 30-year Treasury bills, not for their 2.30% interest income, but for the prospect of 20% to 30% capital gains . This is similar to the advice given a few weeks ago by Kessler’s other long-term bond bull, economist A. Gary Shilling.
With inflation topping 7% and the Fed poised to hike rates, a 10-year Treasury note yielding less than 2% might not look attractive, especially given the prospect of further price declines if yields rise. . Shorter-term Treasuries, such as the two-year note at around 1.50%, are already pricing in much of the rate hikes anticipated by Fed watchers. Either way, safe and liquid assets can protect past gains or provide liquidity for future buying opportunities.
Sometimes fortune favors the cautious, not the brave.
Write to Randall W. Forsyth at [email protected]