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Like Sheep to the Slaughter

Unless you’ve been hanging out on the far side of the moon…

You know Treasury bond investments are a bad bet this year.

Now with yields on the benchmark 10-year note breaking above 3.2% T-bond prices have moved in the opposite direction. The 10-year is down over 10% year-to-date. In contrast the S&P 500 is up 4.6% in the same time frame.

Also, the Federal Reserve signaled there’s likely much more pain to come for bond investors.

The minutes from the Fed’s September meeting were released earlier this week and left no doubt in my mind they remain hell-bent on raising rates even more.

One comment in particular made this crystal clear: “a few participants [Fed members] expected that policy would need to become moderately restrictive for a time, and a number judged that it would be necessary to temporarily raise the fed funds rate above their assessments of its longer run level.”

The Fed also confirmed its intent to keep unwinding the central bank’s bloated balance sheet by unloading $50 billion per month worth of Treasury bonds and mortgage backed securities. The $2 trillion worth of bond purchases during QE (quantitative easing) from 2009-2017 has now turned into $600 billion per year of bond sales.

I call it quantitative tightening (QT).

Source: The Federal Reserve

Simply stated… Higher interest rates and more supply of Treasury securities is a double-whammy for bond prices and a headwind for stocks as well.

This marks a clear path to higher interest rates than markets have expected, and sooner than expected too.

In fact, Fed funds future prices jumped on the news, now indicating 80%-plus odds of the next rate hike in December, and better than 50% chance of yet another increase in March.

The Fed will not rest, apparently, until short-term interest rates (measured by the 2-year Treasury note) are 3% or higher.

This is a good news/bad news scenario for stocks.

A climate of higher interest rates amid a strong economy helps boost corporate profits. But the flip-side is rising inflation (from both trade tariffs and higher material costs). Plus rising labor costs conspire to crimp profit margins, and lowers stock market valuations.

Bottom line: The Federal budget deficit is getting deeper, which means more Treasury securities must be sold to finance this debt.

At the same time the Fed’s rate hike path is making it much more expensive to service that debt. On top of that, the Fed has become a net seller of Treasuries.

This is a major shift in the supply/demand picture for T-bonds that will only get worse as interest rates keep rising.

Allocate your money accordingly.

Here’s to growing your wealth,

Mike Burnick

Mike Burnick
Chief Income Expert, Mike Burnick’s Wealth Watch

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