Rate Rapids

Interest rate volatility has become very topical recently. While rising rates can be detrimental to asset valuations, it’s the rapid rise in rates that has the most harmful impact, especially on long duration assets. For example, 20 and 30 year bonds have experienced the greatest losses in the bond market in the wake of the recent acceleration in the rise of rates. Technology stocks, whose valuations were already arguably stretched, continue to get whipsawed as rates have jumped around this year.

We showed the below chart in last week’s post. While the reversion in the growth to value relationship peaked and began reversing back in the Fall of 2020, it has gained serious momentum since mid-February after an acceleration in rate increases took hold.

Rates appear to have been following inflation expectations higher. What’s interesting is that inflation expectations are higher than interest rates right now, which hasn’t happened since the 2012-2013 timeframe when inflation expectations peaked at a little above 2.5% and then entered a three-year downtrend in expectations. Interestingly, and likely unrelated to today, the S&P 500 increased by 24% during the 16 month period where breakeven rates were higher than interest rates. Today, we are observing inflation in commodity and other input prices, but those increases aren’t pushing popular inflation metrics like the Consumer Price Index (“CPI”) or the Personal Consumption Expenditures (“PCE”) index meaningfully higher. It will be interesting to see if we actually experience sustainably higher inflation this time around.

The other less discussed element to higher rates is the amount of debt being sold by the US Government. In its simplest terms, there’s a massive increase in supply of US Treasuries but the demand doesn’t appear to be there necessarily. As a result, prices have to come down, or rates need to increase, to balance the supply and demand. Demand for Treasuries at recent auctions has been lackluster at the rates being offered. Even if inflation expectations level off and become more tempered, rates could still increase like they did in 2013 when the Federal Reserve hinted at tapering its bond purchases. We probably won’t experience another taper tantrum, but the increase in the debt supply could push rates higher.

Regardless of interest rates, it appears a shift from growth to value has been underway since the Fall of last year. Faster rate increases could lead to an accelerated shift in this trend. However, if rate increase accelerate too much that won’t be good for any stocks.