by TBSchemer
It means IT’S SHOWTIME!
So you know how the Fed has been hiking interest rates to suck liquidity out of the system and reduce inflation, right? The mechanism of this is that investors see the high interest rates, and they move their money into bonds, while avoiding taking on new debt, avoiding risky assets (e.g. stocks, real estate, etc). This effectively deleverages the economy.
But over the last year of rate hikes, for whatever reason, the investors simply didn’t believe the interest rates would actually stay high. JPow kept saying rates would be higher for longer, and analysts kept hearing “rate cuts by year’s end!” That led to this crazy yield curve inversion we’ve been seeing, where the long-term interest rates are significantly lower than the short-term interest rates. This meant that, even though rates were hiking, we weren’t really feeling it that much. Yeah, we’re all getting ~5% in our high-yield savings accounts now, but long-term debt (e.g. 30yr mortgages, 84-month car loans) was still relatively cheap.
Well, that’s all changing now. The investors have finally woken up to the reality that JPow is serious-serious about keeping rates high, not just tongue-in-cheek “serious”. So now even the long-term bonds are only being bought at higher yields. The long-term bond yields are rising to catch up with the short-term bond yields, effectively un-inverting the yield curve.
And this brings us to our final destination, of sucking liquidity out of the system: If you can lock in 5% free returns for 10 years, why would you keep your money tied up in a rental property that’s only cashflowing 3.5%? Is it even still worth it to have your money in the risk-prone stock market, just to get a few extra % returns? No, you’re going to cash out and buy risk-free bonds like a financially-savvy Boomer. Shit’s gonna start selling. Fast.
This is the moment we’ve all been waiting for. The impact of the rate hikes is finally hitting, unleashing its true power. You might notice that the yield curve tends to rapidly un-invert immediately (er, 3-6 months) before every recession. This is what the curve looked like in October 2000, and by March 2001, the dot-com bubble popped. It was a similar story at the end of 2007.
So which will be the first domino to fall this time? Nobody knows for sure, but commercial real estate is on its deathbed, residential real estate is still over-inflated, and banks are holding a ton of old (lower-yielding) bonds that are pretty worthless right now. I’d expect the housing market to correct, along with more SVB-style bank collapses soon.
Don’t fight the Fed. In JPow, we trust.