Rates, Rates, Rates, More Rates and Scotch
So… what happened this week?
The usual things. Things were up (retail sales), things were down (jobless claims), and nothing was conclusive.
Even a policy speech by Jerry Powell, our Federal Reserve Bank Chairman, made different media outlets reach very different conclusions.
Some folks thought the Fed was going to raise rates at their next meeting. Some folks did not.
I think they will hold rates steady and wait to see how the very rapid increase in rates will impact the economy – hiring, firing, retail sales, wholesale prices, inventories, new home building, existing home sales, and ultimately, consumer confidence.
What’s pretty clear is that the economy keeps chugging along in spite of all efforts to slow it down.
Christopher Thornburg, a California economist and the proprietor of Beacon Economics, gave a presentation a few weeks ago at an Inland Empire Chamber of Commerce event.
His firm was connected to UC Riverside until he pointed out some fundamental negative characteristics of the impact of the Service Employees International Union – SEIU - on the economy. The SEIU promptly coerced University management into cutting ties with Beacon Economics. In a crystal clear example of irony, the letter from the UC professors and teaching assistants stated: “We unequivocally support academic freedom and freedom of speech”. They really said that. They should have just added “as long as we agree with it.” But I digress.
At any rate, Mr. Thornburg mentioned a new phrase that I had not heard: Quantitative Tightening.
It’s the opposite of Quantitative Easing.
This means the treasury is divesting itself as a huge buyer of bonds and is instead selling them.
In other words, tightening the money supply.
Because it was a HUGE influx of money that got us into this inflation thing in the first place.
And that’s why we have the 10-year bond at almost 5%.
Mr. Thornburg had a LOT more to say, but this is going to be a long letter anyway, so perhaps next week.
Let’s Talk Interest Rates
Why? Well, interest rates determine the income you receive on your deposits and the payments you make on your debts.
OK, folks. I’m going to get a little wonky on this, but stay with me. Or get to your second cup of java.
In April 2021, the US inflation rate was 4.16%. The 10-year treasury bond yield was 1.6%. Now, let’s break this down.
In April 2021, costs for consumer items were 4.16% higher than 12 months earlier.
At the same time, if you wanted to purchase a 10 treasury bond, it would pay you 1.6%.
That’s a bit of an imbalance, wouldn’t you say? On average, what you are buying costs 4.16% more than a year ago, but if you want to save your money, you are only going to get 1.6%.
It’s a bit more complicated than that, but let’s go with this.
Let’s fast forward to today.
The annual inflation rate for the United States is 3.7%.
The yield (interest rate) on the 10-year treasury is 4.92%.
Now that’s more like it. At least your savings is ahead of your expenses.
“So what?” you say.
From an open market perspective – assuming you think that there is such a thing as an open market – the narrative has changed dramatically in the last 30 months.
30 months ago, while inflation was going up, the market didn’t think it was a big deal. This was evidenced by the fact that although inflation was 4.16%, in a short period of time it would be back down. Consequently, the long-term – 10-year – treasury really shouldn’t be that impacted and it wasn’t.
In other words, things would soon settle back down, and folks would get on with their lives.
How things have changed. Now, with the 10-year treasury at almost 5%, the market is saying that if you want my money for 10 years, you are going to have to pay me for the inflation risk. 30 months ago, that wasn’t a big deal. Today, it’s a big enough deal that if you lend the government money (buy their bonds), you won’t do it for less than 4.92% in spite of the fact that inflation is back down to 3.7%.
The market is saying that inflation is going to be higher for a while. Not 10 years necessarily, but enough that the investor of a 10-year bond wants more compensation to take on the risk of time.
Let's sum up the last 15 bullet points: we’re not going down to a 2% inflation rate anytime soon. This is probably the new normal, so you’d better plan on it until something tells you otherwise.
Using one example, I don’t think you should project your interest expense for your business to be in the 3% range for the foreseeable future.
I would plan on 8 to 10%, actually. And if it drops, that’s a bonus.
I saw a credit card application that had a 30% APR – annual percentage rate. I sure hope it came with a good points program.
Epilogue to the Interest Rate Discussion
Many people are complaining about high mortgage rates.
“Homes are unaffordable!”
“This is unsustainable!”
Predictably, it slows down the purchase of homes because the loan payment becomes higher and it becomes more difficult to make the house payment.
Oddly enough, the folks who are gnashing their teeth and clutching their pearls about high mortgage rates don’t seem to be particularly disturbed about the high cost of borrowing (the budget deficit) the US government has.
That would be the 10-year treasury, which we just talked about.
That is also unaffordable and unsustainable, particularly since Uncle Sam really got addicted to 1.5% rates. And now it has to pay 5%.
Maybe I’ll save that for another report.
And finally…
What is The Macallan?
Well, if you are a whisky aficionado, you know that it is a brand of whisky, and because it is distilled and bottled in Scotland, it’s referred to as scotch whisky.
A single bottle of The Macallan 15-year-old scotch is priced around $150.
So, what would a bottle of The Macallan 1926 cost?
We’ll find out on November 18, because that’s when it comes up for auction at Sotheby’s.
The last one sold at auction in 2019 for over $1,500,000. Yep, count the zeros.
Sounds like the economy is still pretty good.
69 days left in the year.
