After an epic (generation-spanning at the long end) decline in interest rates, the trend has finally reversed. Which means, if history is still a reliable guide, there’s a number that ends this cycle and ushers in the next recession and equities bear market. But what is it?
Here’s a chart (from MishTalk via Crescat Capital) that shows the relationship between short term interest rates and economic recoveries. In cycles past the Fed has responded to building inflationary pressures by raising the Fed Funds rate, and eventually the rising cost of short-term loans either caused or coincided with the expansion’s end. Note that in the past it didn’t necessarily take a long, dramatic rate increase. Just a change in direction over a year or two was enough to turn growth into shrinkage.
Meanwhile at the longer end of the yield curve interest rates are jumping as well – also in response to the perception that inflation is becoming a thing again. Here’s the 10-year Treasury bond yield since 2016:
This rate matters in part because it’s how banks price 30-year mortgages. Already it’s having a profound effect. See Mortgage rates are surging to the highest level in 7 years.
Last but not least, the relationship between short and long rates is a number, and might end up being the one we seek. The following chart shows the 10-year Treasury yield minus the 2-year Treasury yield. When it drops below zero the curve is inverted, which has historically signalled a slowdown. So the magnitude of the (apparently) coming yield curve inversion is a big deal.
The frustrating thing for investors (including short sellers) is that, as all three of these charts illustrate, there is no historically magic number that always does the trick. Rates in general have been falling over the past few decades as government financial mismanagement has required ever-easier money to keep the game going.
This means that it might not take a return to, say, the 8% Fed Funds rate of 1990 to blow up the system; a much lower rate – spread out over vastly more debt – might do the trick. Same thing with mortgages. In the healthier past a 6% rate on a 30-year mortgage was low enough to excite home buyers. Now 4.5% is pricing homes out of most Americans’ reach.
So the exact number on the exact indicator that turns a steady expansion and robust bull market in a brutal bear market will only be known in retrospect. In the meantime we’ll just have to pay attention and hope that the end, when it comes, provides at least a little warning.