From Guggenheim Partners:
September 18, 2013
Rising Interest Rates Must End Soon
The yield on the benchmark 10-year U.S. Treasury bond has risen by more than 84 percent from May to early September, one of the most violent and rapid increases on record. This spike has caused severe convulsions in the bond market, leading many investors to wonder how long the torment can last.
If history is our guide, the answer is that it may be over soon. Investors would be wise to remember that “soon” is a period of time, not a matter of degree. I make this point to be clear that while long-term interest rates still have room to increase in this historic bear market—maybe even significantly—now may be the most opportune time to purchase longer duration fixed-income securities in the past two years.
Largest Rise in 50 Years
On June 19, Ben Bernanke amplified signals that the Federal Reserve was preparing to taper bond purchases as part of his roadmap to unwind quantitative easing. His words, intended to calm markets, did just the opposite, spurring an unprecedented rise in rates. Rates began to move sharply higher in early May when the Fed turned hawkish and really took off after Bernanke’s comments.
The increase in U.S. Treasury yields of more than 115 percent since their bottom in July 2012 is greater on a percentage basis than any cyclical increase from trough to peak in the past 50 years. Previously, the largest such increase was 94 percent between December 2008 and April 2010. With history as our guide, we are now only days from the average length of such bear markets. The average time from trough to peak is 423 days. Now as Fed policymakers meet to discuss tapering asset purchases, it has been 420 days since rates last bottomed in July 2012.
Once rates peak, the average decline of the previous 16 interest rate cycles is 35 percent. That means, if 3 percent was the top of the current interest rate cycle we could expect rates to fall below 2 percent before another meaningful sell-off. Similarly, if rates continue to rise and top out at 3.5 percent, the trough could be 2.25 percent if averages hold. Whether rates on 10-year Treasury notes continue to rise from here or not, this could be a relatively good entry point to purchase long-duration bonds.
Buying Opportunity Near
The reality of how badly higher interest rates are hurting the economy is slowly becoming apparent and may soon prompt a reversal of fortune for bond investors.HT: ZeroHedge
So, what should an investor do? Now may be the time to consider adding to fixed-income assets, especially longer-duration bonds. Given the strong, negative sentiment, history tells us that a buying opportunity cannot be far away. While there is additional downside risk, no one can pick a top or bottom in markets with complete precision. But if history is any indication, 10-year rates may be heading back to 2.25 percent or lower, meaning the bet may pay off.
Why should interest rates decline? Since the Fed turned hawkish in May, higher interest rates have sent mortgage rates skyward. The abrupt rise in mortgage rates is having a material impact on housing activity. With mortgage applications declining, the critical tailwind of housing in the current expansion may soon become a headwind. More than half of all economic growth since last year came from housing-related activity....MORE
