Interest rates—along with economic data and earnings reports—are one of the three key factors that actually matter when it comes to where the market may be headed. Chief Investment Officer Jim Lowell and Vice President Charlie Toole discuss their expectations for the direction of interest rates, inflation and the bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. market for the rest of 2019 in our recent quarterly webinar*: Investing Through Impeachments and Trade Wars.
Please enjoy the excerpt above and click here for the full webinar replay to hear more.
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Charlie Toole: There’s a couple of different factors that we look at that drive the direction of interest rates. Most specifically, the direction of economic growth and the direction of inflation. We got another report on GDP earlier today* where the economy is growing at about a rate of 2% year over year. And while that’s good and positive, that growth rate has been trending down. And as we’ve seen over the last year, in environments when growth rates are trending down, that’s usually a strong tailwind for an interest rate drop.
Charlie Toole: And we’ve seen interest rates drop and bond prices rise over the last year. Because of that, slowing economic growth environment and shifting over to inflation over the past year, inflation’s been trending down as well or having decelerating growth. I think one of the things that we’re going to start to see, and we’re interested in watching how this is going to impact the bond market, is inflation is going to start to rise a little bit. When we look at the price of oil, we’re going to compare that to the price of oil last year when stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. were dropping and the price of oil was dropping. So just with a comparison to low oil prices last year, inflation is going to be higher, it’s not going to be runaway inflation, but it is going to start to have that accelerating type of growth rate.
Charlie Toole: And so it’ll be interesting to see as we’re still in this slow-growth environment, as inflation is starting to pick up. Are bond investors going to focus on inflation rising a little bit, or growth still being slow? And I think over the past three or four months, we’ve seen interest rates, specifically, the 10-year Treasury yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price., float between a range of about 1.5% to 1.9%. I think as we get this push-pull environment where we’re getting economic data and inflation data on a continual basis, we’re probably going to see interest rates be range-bound in that range for the rest of this year.
Jim Lowell: Charlie, can I just jump in and say, I know our bond guru, Chris Keith, points out that 1.8% may feel very low in terms of return on your investment. But compared to some sovereign debt elsewhere, for example, Germany, where there’s a negative yieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price., not only is it attractive, and of course here at Adviser we use bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. as buffers in our growth portfolio as well.
Charlie Toole: Exactly.
Jim Lowell: I’m kind of curious just to hear a short version of your take on this low inflationary environment. It’s been persisting longer than I think a lot of people were expecting it to. The trend now seems to be a higher percentage belief and the probability of going lower over time. What is it to actually be worried about low inflation? Is it a tell on nearing recession? Or is it something that’s going to be a new normal?
Charlie Toole: I think it has been a new normal. I mean, I we’ve heard for 10, 12 years that we’re going to revisit the environment of the ‘70s where inflation was runaway. The Federal Reserve couldn’t control it until Chairman Volcker crushed it in the early ‘80s by raising rates to double digits.
Jim Lowell: 18% on the money market.
Charlie Toole: Exactly. That was really what everybody was worried about. But we’ve been in an environment where inflation has continued to trend lower, part of that has to do with just productivity and technology. You can get everything on your phone with one click of a button. So I think it’s part of this technology. But the other part of it is just we’re still feeling the effects of financial crisis. And that financial crisis happened here in the United States, 10-plus years ago, but Europe has certainly gone through their own crisis.
Jim Lowell: Still struggling.
Charlie Toole: There hasn’t been that coordinated global growth, and that I think it’s kept inflation down.
* Webinar recorded after the market closed on October 30, 2019.
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