A wild week in the financial markets just wrapped up. Stocks were pummeled on Monday and then took a wild roller coaster ride the rest of the week, largely recovering the losses from Monday.
Gold surged past the $1,500 per mark. The signs haven’t been this bullish for gold since its all-time peak back in 2011. All of that could change, however, with a recession.
I think the most significant move this past week came in the bond market. Interest rates, particularly on longer-term yields, fell quite dramatically. The 10-year yield fell to around 1.6% before finishing the week at just over 1.7%. The inverted yield curve continues, and the 20-year yield and 30-year yield are now very close to the short-term rates.
Sometimes falling rates are a sign of a healthy economy. But in this case, I think it is the opposite. We aren’t seeing low rates because of a plethora of savings. It is due to market tampering by the Fed, and it is also due to investors locking in longer-term rates before the next recession hits.
Why would someone lock up their money for 10 years for 1.7% annual interest when they could lock up their money for just 3 months at 2% annual interest? The reason is that they expect the short-term rates to fall well below that 1.7% in the future.
The lowest yields are in the 3-year and 5-year range. This is not surprising. If you thought a recession was coming next year, and the economy would be lackluster at best for a few years following that, then it would make sense to lock in a rate for the next 3 to 5 years.
This Isn’t the 1970s (Yet)
Interest rates do not always have to fall in a recession. In the 1970s, when the Fed continued to print money, and there was a genuine fear of price inflation, rates rose to reflect the inflation premium. If you were going to buy a bond and expected to lose 10% per year to inflation, then you would expect the bond to pay out higher than 10% per year. It is important to note though that real (inflation-adjusted) interest rates can still be negative if that seems to be the best choice around.
The interest rates in Japan and parts of Western Europe are largely negative in nominal terms. However, this is just a reflection of how bad the markets are rigged there. Most of these negative-yielding bonds are being bought up by the central banks.
In the U.S. today, there is not a lot of fear for significant price inflation. Therefore, when we do have a recession, U.S. government bonds will be seen as a safe haven. Most likely, government bonds will be seen as a safe haven even over gold. Rates will continue to fall.
I do expect high price inflation to eventually hit, but it will be after the Fed’s response to the next crisis. It is safe to assume that the Fed will return to quantitative easing (digital money printing) when the next crisis hits.
An inverted yield curve generally occurs before the recession hits. This is why it is such a great predictor of recessions. It is common for the yield curve to go back to normal before the recession actually hits. At that point, interest rates will likely fall, again, assuming there is little fear of price inflation. But short-term rates will then fall faster than long-term rates.
Refinancing
If you own real estate with a mortgage, you may have a chance to refinance in the somewhat near future. Mortgage rates are really low now, but I think they will probably go lower. If you are on the margin about refinancing, then it is probably best to wait. If you already have a high rate (relatively speaking), then you may not want to wait and take the chance. If you can go from a 5% rate to something under 4%, then it will make sense in a lot of cases. Of course, you have to run your own numbers for your own personal situation.
I currently have a 30-year fixed rate mortgage that is just under 4%. This is from 2010. That was amazingly low to me at the time, but the current rates just about match this. If I decide to refinance, it will be to a 15-year fixed rate mortgage, which is getting down near 3%.
It is not quite low enough for me right now to make it worth it, so I will wait to see if rates drop more. If I can get a monthly mortgage payment within $100 of what I currently have, while knocking about 6 years off of my loan, then I will likely do it.
It is obviously quite difficult to make predictions with these markets. The timing is even harder. At this point, the mostly inverted yield curve is pointing to a recession in 2020.
Stocks are going to get pummeled. I won’t be surprised if share prices get cut in half or more.
Gold could go either way. I expect it to retreat a little in a recession, as people look for liquidity. I expect it to eventually go much higher when the Fed starts creating new money again like crazy.
Bonds are likely going to go up even more, as interest rates fall. The fall in longer-term rates may not last that long, so don’t procrastinate on refinancing if it is something that makes sense. I expect short-term rates to go near zero again, and they are likely to stay there as long as the threat of high price inflation remains low.