Market Beat: Interest rates and inflation
July 28, 2014
Recently, Fed chair Janet Yellen gave her semi-annual Humphrey Hawkins testimony to Congress regarding Fed policy. QE, or quantitative easing, is supposed to end in October, and most Fed officials don't expect to start raising interest rates until next year.
Investors with bond holdings need to be aware of the impact that rising interest rates could have on their portfolios.
Long dated bonds are very sensitive to changes in rates. Many investors have been stretching for yield by buying junk bonds, and Yellen mentioned in her testimony that junk bonds appear to be overvalued at these price levels.
She also said that, "a high degree of monetary policy accommodation remains appropriate," and is particularly focused on the labor markets. Remember the Fed's mandate is to control inflation and foster full employment.
Our labor market is actually doing pretty well by several metrics. For five months in a row we've seen over 200,000 jobs created, this hasn't happened since 1997. The unemployment rate has dropped to 6.1 percent and unfilled jobs stand at 4.64 million, which is almost a record.
The BIS, Bank of International Settlements, based in Basel, Switzerland, published a report saying that the world's central banks should be very careful not to fall into the trap of raising rates "too slowly and too late."
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Both the Fed and the ECB, the European Central Bank, brushed off the BIS warning and reiterated that they are committed to accommodative monetary policies for the foreseeable future.
The BRICS have made an announcement that they will be forming their own central bank which could be a rival to the World Bank and the International Monetary Fund.
BRICS stands for Brazil, Russia, India, China and South Africa. Forming their own bank could have a real impact on the world monetary establishment.
We've also been seeing increased foreign holdings of US Treasury debt. Foreign nations are trying to keep the value of their currencies low to increase their exports. They print more money, exchange it for dollars, and lower the value of their currencies — then they use the purchased dollars to buy US Treasuries, which acts like a form of quantitative easing, but the bonds purchased are not under Fed control.
In the last Treasury auction, the world's major banks accounted for 52 percent of the sale, which is 10 percent more than normal and the most since February 2006.
Investors with long term bonds and high yield bonds should be aware of how their holdings could drop in value in a rising rate environment.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.