Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Tory Leadership Contest - Will Michael Gove Stab Boris Johnson in the Back Again? - 19th May 19
Stock Market Counter-trend Rally - 19th May 19
Will Stock Market “Sell in May, Go Away” Lead to a Correction… or a Crash? - 19th May 19
US vs. Global Stocks Sector Rotation – What Next? Part 1 - 19th May 19
BrExit Party EarthQuake Could Win it 150 MP's at Next UK General Election! - 18th May 19
Dow Stock Market Trend Forecast 2019 May Update - 18th May 19
US Economy to Die a Traditional Death… Inflation Is Going to Move Higher - 18th May 19
Trump’s Trade War Is Good for These 3 Dividend Stocks - 18th May 19
GDX Gold Mining Stocks Fundamentals Update - 17th May 19
Stock Markets Rally Hard – Is The Volatility Move Over? - 17th May 19
The Use of Technical Analysis for Forex Traders - 17th May 19
Brexit Party Set to Storm EU Parliament Elections - Seats Forecast - 17th May 19
Is the Trade War a Catalyst for Gold? - 17th May 19
This Is a Recession Indicator No One Is Talking About—and It’s Flashing Red - 17th May 19
War! Good or Bad for Stocks? - 17th May 19
How Many Seats Will Brexit Party Win - EU Parliament Elections Forecast 2019 - 16th May 19
It’s Not Technology but the Fed That Is Taking Away Jobs - 16th May 19
Learn to Protect your Forex Trading Capital - 16th May 19
Gold Ratio Charts Offer The Keys to the Bull Market - 16th May 19
Is Someone Secretly Smashing the Stock Market at Night? - 16th May 19
Crude Oil Price Fails At Critical Fibonacci Level - 15th May 19
Strong Stock Market Rally Expected - 15th May 19
US China Trade Impasse Threatens US Lithium, Rare Earth Imports - 15th May 19
Gold Mind Reader's Guide to the Global Markets Galaxy: 'Surreal' - 15th May 19
Trade Wars and Other Black Swan Threats to Your Investments - 15th May 19
Our Long-Anticipated Gold Momentum Rally Begins - 15th May 19
Defense Spending Is Recession Proof - Defense Dividend Stocks - 15th May 19
US China Trade Issues Will Drive Market Trends – PART II - 14th May 19
The Exter Inverted Pyramid of Global Liquidity Credit risk, Liquidity and Gold - 14th May 19
Can You Afford To Ignore These Two Flawless Gold Slide Indicators? - 14th May 19
As cryptocurrency wallets become more popular, will cryptocurrencies replace traditional payments? - 14th May 19
How US Debt Will Reach $40 Trillion by 2025 - 14th May 19
Dangers Beyond a Trade War with China - 14th May 19
eBook - Greatest Tool for Trading? - 14th May 19
Classic Pitfalls for Inexperienced Traders - 14th May 19
Stock Market S&P 500 Negative Expectations Again - 13th May 19
Why Rising Living Standard in China Offers Global Hope - 13th May 19
Stock Market Anticipated Correction Starts On Cue! - 13th May 19
How Chinese Trade Issues Will Drive Stock Market Trends - 13th May 19
Amazon SCAM Deliveries for Fake Verified Purchaser Reviews "Brushing" - 13th May 19
Stock Market US China Trade War Panic - Video - 13th May 19
US Stock Market Leading Macro Economic Indicators Update - 12th May 19
SAMSUNG - BC94.L - Investing in AI Machine Intelligence Stocks - 11th May 19
US Increases Trade Tariffs Against China – Stock Markets, Gold, and Silver - 11th May 19
Who Has More To Lose In A No Deal Brexit? - 11th May 19
Gold at $1,344 Will Start Real Fireworks on the Upside - 11th May 19
Make America’s Economy Great Again - 10th May 19
Big US Stocks’ 2019 Fundamentals - 10th May 19
Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - 10th May 19
Stock Market Shake-Out Continues – Where Is The Bottom? - 10th May 19

Market Oracle FREE Newsletter

U.S. House Prices Analysis and Trend Forecast 2019 to 2021

Low Interest Rates Won't Hide This Looming Threat Forever

Stock-Markets / Financial Markets 2014 Jun 04, 2014 - 04:22 PM GMT

By: Money_Morning

Stock-Markets

Michael E. Lewitt writes: Financial markets are experiencing a significant divergence in 2014 between the direction of stocks and bonds.

While the S&P 500 and Dow Jones Industrial Average have traded to new record highs, the yields on benchmark Treasury bonds have dropped sharply.


Normally, one would not expect stock prices to rise and bond yields to drop simultaneously because these movements suggest contradictory readings of the economy.

Higher stock prices indicate bullishness about economic growth, while lower bond yields suggest just the opposite.

However, the inconsistent signals being sent by markets are not as surprising as they seem, given the context of the post-crisis environment in which Federal Reserve policies have distorted normal market pricing mechanisms.

This situation could blindside investors who don't see it coming...

Signs of Growth Are Appearing

Investors are being forced into riskier investments such as stocks and high-yield bonds in order to generate returns.

Investors have become confused about what constitutes risk.

They now believe that investments such as Treasurys and other government bonds, which offer miniscule nominal returns in a low-inflation environment and negative returns in a normalized or high-inflation environment, are low risk.

They are going to learn, to their detriment, that such investments are actually high-risk when central bank policies designed to suppress normal market functions fail to accomplish their goals, unleashing hyperinflation.

The latest government data shows that the U.S. economy shrank at an annual rate of -1.0% in the first quarter. Consensus estimates were much higher. While many observers are attributing slow first-quarter growth to bad weather, other factors contributed to poor economic performance.

Slower-than-expected inventory builds slowed growth by -1.6% in the period.

The good news is that this inventory drag should not recur in the second quarter. In addition, there are other signs that second-quarter growth should improve. Bank lending has been accelerating at a 9.5% annual rate over the past 17 weeks according to ISI Group.

One of the factors slowing post-crisis growth has been the trillions of dollars of dormant capital sitting on bank balance sheets; now that some of that capital is beginning to circulate in the economy, growth and inflation should pick up.

There are other signs that the economy is gaining some steam this spring, including recent employment and housing numbers along with more specific data such as total railcar and intermodal traffic volumes up 6% on a year-over-year basis, truck tonnage up 5%, port activity in Long Beach, Calif. (one of America's largest ports), up 5%, and rising hotel revenues. Second-quarter GDP growth is likely to hit 3%, which should place a floor under bond yields. The more important question is whether the economy can maintain that strength over the second half of the year. If it can, bond yields have likely seen their lows for the year.

Despite Low Rates, Bond Buying Continues

In addition to slow U.S. growth, there are other reasons why investors are flooding into bonds despite their low yields.

Many institutional investors are rebalancing their portfolios after 2013's heroic equity gains. Many institutions are engaging in long-term liability management at precisely the wrong time by shifting assets into long-term obligations paying extremely low yields. This virtually guarantees long-term underfunding since their liabilities are continuing to rise at high single-digit rates. This may be unwise, but it is happening nonetheless.

And European interest rates have dropped significantly, based on public statements by European Central Bank President Mario Draghi promising action to stimulate still-struggling European economies.

The ECB is expected to lower its benchmark lending rate and to impose negative rates on funds held at the ECB. This has resulted in yields on the bonds of weak peripheral countries such as Spain and Italy trading below 3%, which in turn has placed further downward pressure on global rates.

Third, and perhaps most importantly, the Federal Reserve has engaged in what is called "forward guidance," which is Fed-speak for...

...when the Fed speaks. Federal Reserve Chair Janet Yellen has repeatedly stated that she has no intention of raising interest rates for the foreseeable future. The market appears to take her at her word even though recent inflation and jobs data are starting to undercut the case for keeping the Federal Funds rate at zero for a prolonged period of time.

Don't Be in This House of Cards When It Falls

The reality facing the Federal Reserve is that the U.S. economy remains too weak to withstand higher rates. The housing market weakened considerably after interest rates rose by 100 basis points in the summer of 2013.

The federal budget deficit would explode were interest rates to normalize. The entire edifice of leveraged finance would collapse under its own weight if interest rates rose by 200 basis points, dragging into bankruptcy a number of large leveraged buyouts.

For this reason, the Federal Reserve will continue to use its considerable powers to suppress interest rates far below their natural levels for as long as possible. This will have the ironic consequence of helping stock prices continue to levitate despite the fact that low interest rates are a symptom of economic weakness, not economic strength. And while interest rates are likely to rise from their current levels, they are unlikely to spike in the foreseeable future.

The Federal Reserve will see to that.

Instead, rates will remain below normal in order to maintain the post-crisis status quo and give the economy time to grow. The problem is that the economy will never be able to grow fast enough without dramatic fiscal and tax policy initiatives. The current mix of 2% to 3% growth and tepid inflation are offering the veneer of stability that markets like.

Unfortunately, the divergence between stock and bond prices is a warning that this scenario is unsustainable.

Sooner or later, markets are going to demand more growth to service the enormous debts that have been incurred to rescue the global economy from the financial crisis.

If that growth does not materialize - and it is unlikely to do so without dramatic fiscal and tax reforms - equity markets in particular are likely to face a heavy reckoning.

Up Next

This divergence, along with inflation that runs 3% to 4% above the "official rate," could wipe out unprepared investors. But these simple moves could save your financial future... Full Report

Source : http://moneymorning.com/2014/06/04/low-rates-wont-hide-this-looming-threat-forever/

Money Morning/The Money Map Report

©2014 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules