Back in December, the Federal Reserve hiked interest rates for the first time in more than eight years. As a result, markets reacted by throwing a hissy fit in the ensuing weeks.
Now, Fed officials are strongly hinting that the next hike is forthcoming – if not at the June 14-15 meeting, then probably at the July 26-27 one. So does that mean investors are in for another bout of turmoil?
Wall Street is worried that the Fed is tightening right into an economic slowdown, and thus maybe in favor of it. Several data points on everything from durable goods, to retail sales, to commercial real estate, point toward a potential slowdown in the U.S. economy. Yet, the Fed is now poised to raise rates for a second time.
That’s why we’re seeing the Treasury yield curve flatten significantly. The difference in yield between 2-year Treasuries (which are most sensitive to Fed action) and 10-year Treasuries, (which are more attuned to long-term growth expectations) has narrowed to just 94 basis points, or 0.94 percentage points. That’s the flattest the curve has been since November 2007. You may recall that the fall of 2007 was also the peak of the last bull market.
On the other hand, spreads in the credit market have tightened in the past several weeks. Some of that stems from the decision by the European Central Bank to add corporate bonds to the list of securities it can buy. Some of it stems from the rebound in oil prices, which has eased stress in the energy sector. That would tend to suggest the market can withstand another rate rise.
So what’s my take? I believe we’re late in the credit and economic cycle. Real estate magnate and billionaire Sam Zell went so far as to characterize this as a “ninth inning” environment, and that he was raising cash and investing less as a result. If that’s the case, continuing to hike interest rates could definitely lead to more market turmoil because it will exacerbate the weakness we’re already seeing in many sectors.
Bottom line? Proceed with investing caution here ahead of the Fed’s next potential hike.
Until next time,
Mike Larson is a Senior Analyst for Weiss Research, and is also the creator of the course “How to Profit From Rising Interest Rates”. A graduate of Boston University, Mike Larson formerly worked at Bankrate.com and Bloomberg News, and is regularly featured on CNBC, CNN, Fox Business News and Bloomberg Television as well as many national radio programs. Due to the astonishing accuracy of his forecasts and warnings, Mike Larson is often quoted by the Washington Post, Chicago Tribune, Associated Press, Reuters, CNNMoney and many others.