The weird silver lining of high interest rates
the Fed is likely to raise rates
The jobs report came out last week, and it was shockingly strong … the U.S. added 172,000 jobs, more than doubling Wall Street’s expectations (analysts were estimating 85,000)
(Also, Canada’s jobs report was shockingly strong as well — they added 87,800; analysts were only expecting 10,000)
Weirdly, the market fell on the good news, which sounds counterintuitive at first — until you consider that strong jobs is an indicator that the Fed is definitely not going to be cutting rates anytime soon.
In fact, most analysts are estimating that the Fed will likely raise rates before the end of the year.
Investors are pricing the expectation of a Fed rate hike into sky-high bond yields; late last month, the 30-year Treasury hit 5.2 percent (ugghhh RIP your mortgage aspirations)
Okay, I realize I just threw a lot at you, so let’s quickly recap before we give this a plot twist:
– jobs are strong
– but inflation is still high
– therefore Fed will likely raise rates in coming months
– which means investors are demand huge yields from long-term bonds
– which is why you’re struggling to buy / refi a home
Clear as mud? Okay, let’s continue because there’s a plot twist to all of this …
this might be sparing us from an AI bubble
Recently, Bloomberg ran a fairly convincing op-ed arguing that these insane bond yields are the reason that we’re not in an AI bubble.
(I know, this piece is starting to sound like Mad Libs, but bear with me.)
Bond yields are super high at the same time that the stock market is on a tear. the S&P 500 had nine consecutive weeks of gains, ending last week.
Bloomberg argued — and I think this actually sounds reasonable — that if bond yields were lower, meaning capital was cheaper to access, investment would be even higher, and then we might actually be in a bubble.
The high cost of capital, in other words, might be the thing that’s keeping the market sane.
It may not be bringing inflation down to our preferred target — inflation is 3.8% as of April — but it might be cooling the economy just enough to keep us from true bubble territory.
And that’s why we can enjoy what is historically a very rare phenomenon, which is absolutely incredible stock market growth at the same time as high long-term bond yields.
(Typically, high bond yields put downward pressure on stocks … so our current stock market run is, well, weird.
Yeah, I said it: it’s weird.
But it’s also excellent news for anyone with a retirement account)
I realize the message “it’s not a bubble” is small consolation when you’re facing the reality that mortgage rates are likely to stay above 6% for the foreseeable future (at least the rest of the year, maybe longer).
But the silver lining is that these high bond yields, and therefore the high mortgage rates, might be the thing that’s keeping your 401k from imploding.
bubbles result from short-term thinking, not high valuations
Of course, we can’t talk about bubbles without addressing the common misconception: “what goes up must come down.”
Many investors have a fear of heights, and mistakenly think that high valuations indicate a bubble.
And given that the stock market has essentially been on a continuous bull run since 2009 (with the exception of, like, a minute in 2020), some people are worried that we’re due for a cyclical recession.
But there are two misconceptions embedded in this:
– bull markets don’t die of old age
– bubbles are created by short-term thinking, not high valuations
This idea is best explained by Morgan Housel, a three-time podcast guest, who describes how bubbles are created when short-term traders start influencing the market too much.
People who normally would have a long-term orientation start taking their cues from short-term traders.
A hype cycle ensues.
That time horizon confusion … that’s the actual warning sign of a bubble.
It isn’t high valuations in and of themselves that’s the problem.
The problem is investors following the herd, not realizing that the herd is being led by people with shorter time horizons.
The takeaway? DON’T have a fear of heights. DO have a fear of short-term thinking.
(p.s. I chatted about both the jobs report and the bond market in my First Friday episode, which aired a few days ago. Tune in if you’d like further listening.
That’s Three Things Tuesday, folks! — this is the 7th Edition
We covered a LOT of ground — the jobs report, the bond market, inflation, Fed rates, bubbles, hype cycles, and high valuations.
Please hit reply and let me know if you have any questions about this, or if you want a deep dive primer explaining how these concepts all link together.
“Three Things Monday (er, Tuesday)” is formatted as quick hitters, but I can write a deep dive if there’s enough interest.
