I read today on the Bloomberg new service that the yield on US Treasuries (which is a quick way of summarising the price of US Government bonds) has fallen to a level that implies the US Federal reserve will CUT interest rates 3 times next year. That is not altogether what one might predict!
It seems that worries about trade wars and other factors are prompting big players to buy Treasuries, either to profit from such rate cuts, or because they think there will be a US recession, or both. Apparently there is a strong view that such a recession is on the way. If there is and bank rates fall then the ‘hedge’ might work and provide some compensation when equity prices collapse.
But the idea of a US recession is hardly good news. Much as we don’t rejoice in making an insurance claim when some disaster happens, we are unlikely to be happy to make a bit on our exposure to the US bond market if we are seeing our equity portfolios trashed.
What if US interest rates don’t fall? With very high employment levels and Trump’s tariffs likely to push up inflation, then there is some probability that they won’t. They may even go up more. In that case, the yield on Treasuries will need to rise and values will fall. That may also be bad news for equity markets and furthermore at some stage a recession will happen. So there could be a double whammy.
In that case investors will have to ponder the storm damage and realise that the insurance is not going to help.
I take the view that as political risk remains (unusually) the most significant and that means normal economic considerations are out the window, it is best not to bet on the direction of interest rates but to assume a revaluation downwards in equity markets as troubles build up. In that case, I prefer to hold cash.
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