​What Goes Up, Must Go Higher Yet

Ivan Illán  |

At the beginning of this year, 90-Day US Treasury Bills yielded 0.528%. Today, it’s 1.350% - a 155% hike. My forecast (as formally recorded each year with the CFA Society, Los Angeles) targeted 0.972%, by 2017 year-end. Even this aggressive outlook would have been an 84% rate increase. Reality, however, has been stranger than fiction.

Regardless, the lack of precision in my short-term Treasury bill yield forecast doesn’t concern me. The magnitude of the move was the point, and more critical element, of this forecast. The 3-month yield jump was so much more significant than even my extremely aggressive forecast. To me, it spells continued challenges in 2018 for the Federal Reserve, our global money markets, and the velocity of money – none of which bode well for fixed income investors, primarily, and equity investors secondarily.

With all the excitement of being on the precipice of a new tax bill passing this week, I look more towards underlying economic fundamentals to indicate where corporate earnings will go in 2018. It’s becoming abundantly clear that “this time is not different”, as the Fed shifts monetary policy from very accommodative to much more restrictive. As with past monetary policy cycles, the proverbial pendulum must now swing in the opposite direction, and with accumulated force.

How will this effect bank lending? Until long term rates are much higher than short term ones, don’t be too optimistic that banks will be adequately incentivized to lend. After all, they’re currently earning 1.00% on their excess capital reserves. That’s a windfall compared to the current 2-10 Year Treasury Spread of 0.52%.

If banks don’t care about lending, then consumers (who’ve already cut back somewhat) will have less access to finance purchases, which puts further pressure on corporate earnings, as top line revenues sag. On the bright side, business spending has been taking up some of the slack, in anticipation of tax savings.

I usually enjoy having a forecast come to fruition, especially one that no one was publishing at this year’s start. But, this one gives me very little joy, as the complex web of monetary easing must now find its way back to normalization. I think even electro-shock therapy (from what I understand) may provide a more pleasant experience.

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