Introduction LO:
In my 2020 blog, Hope for the best, plan for the worst, I wrote about the dangers of the Modern Monetary Theory (MMT) and included this sentence:
“That changes dramatically when – and not if – interest levels will rise again.”
Long-term US interest rates are rising since several weeks, and are just above zero now. This is very interesting because two forces have been fighting each other for years:
- An increase in money supply (eg, printing or QE) causes interest levels to go down;
however, - when (money) supply exceeds demand then inflation starts and interest levels go up.
For years, #1 ruled the markets and thus Modern Monetary Theory gained in popularity.
Now, it seems that #2 is winning because money supply has become too big and lacks a useful destination. An example is the popularity of Initial Public Offerings (IPO’s) for Special Purpose Acquisition Companies (SPAC’s). The balance sheet of a SPAC is simple: 100% cash. The SPAC is just waiting for an acquisition, any acquisition.
Moreover, rising interest rates have – traditionally – caused the following:
- when interest levels go up then share prices go down (due to DCF valuation);
- when interest levels go up then bond prices must go down (due to mirroring of nominal rates to market rates).
Financial markets are already getting nervous following inflation prospects and rising long-term interest rates. This nervousness probably also explains why “the Dow Jones Industrial Average [was] briefly hitting 32,000 for the first time in history” (Fox Business).
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Axios title: The cost of money has been rising significantly
By: Dion Rabouin
Date: 22 February 2021
“U.S. real yields are rising, meaning the cost of borrowing money is again turning positive — at least for longer maturities.
Why it matters: Borrowing money has essentially been free for quite some time, benefiting big companies (and governments) by allowing them to accumulate huge sums of debt that have little real cost.
- Negative real yields — the value of U.S. Treasury yields minus inflation — have been a major justification for extreme price-to-earnings ratios for U.S. stock exchanges, particularly the Nasdaq.
State of play: The yield on 30-year Treasury Inflation-Protected Securities, aka real yields, turned positive on Friday for the first time since June 2020, according to Tradeweb data, punctuating a sizzling pickup that has been brewing over the last week.
- 30-year real yields have risen 27 basis points from their Feb. 10 close and are up 40 basis points so far this year.
- 10-year yields remain negative but have risen by 25 basis points since Feb. 10.
Be smart: “This means the economy is on the mend; so it’s not unhealthy that real yields are rising,” Mark Holman, CEO of TwentyFour Asset Management, told Bloomberg.
- “But I caution that if real yields rise too quickly, then that’s a problem for all asset classes. It’s the speed of the change that could be a worry.”
The big picture: Increasing inflation expectations have sent nominal Treasury yields to their highest levels in nearly a year for 10- and 30-year maturities, with breakeven rates — which measure inflation expectations over time — rising to multiyear highs as well.
- The difference between yields on the 5-year and 30-year Treasury bonds rose to the highest since 2014.
What to watch: A main reason for the increasing yields has been the Fed’s insistence that it won’t put the brakes on its easy-money policy and will allow for prices to run above its 2% target for “some time.”
- New York Fed President John Williams said on Friday that he is not worried that too much government spending could overheat the U.S. economy.”
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Source:
https://www.axios.com/money-cost-rising-significantly-83886dd8-3d49-4b65-9c88-ce217d502564.html
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