In the last couple of weeks I have developed a thesis around the idea that interest rates (and by interest rates I mean long end rates like the 10-year and 30-year US Treasury yields) will move appreciably higher during 2018. Here are some of my reasons for expecting a bad year for bonds and a rising yields environment in 2018:
- The Institute for Supply Management (ISM) non-manufacturing operating rate (a metric which is currently pointing to a robust economy) has surged, which has historically indicated that an uptick in core-CPI is on the way:
- Euro Area inflation is trending higher and on the verge of a "breakout" above the 2.0% level:
- The GOP tax bill is poised to increase budget deficits by more than $1.4 trillion over the next ten years which will increase Treasury debt issuance and presumably add pressure (through increasing supply) to long term Treasury note/bond pricing.
- An increasingly undersupplied global oil balance is likely to keep a firm bid under crude oil prices throughout 2018, only adding to inflationary pressures:
- 10-year US Treasury yields bottomed in 2016 and have since formed the right shoulder of a large head & shoulders bottom pattern with a slanted neckline:
As fund manager Jeffrey Gundlach has stated, a move above the 2.62% yield level (the high from earlier this year) could indicate the secular bond bull market is over and that the 10-year yield could reach as high as 6% within five years.
So how does an investor prepare for a rising yields/inflation environment? More on that later in the week.
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