Scholarship

Should we be afraid of an explosion of interest rates and a collapse of bonds?

Interest rate markets have been giving investors a cold sweat for six months now. The US 10-year rate has more than doubled since its lowest in the wake of the Ukraine invasion shock, and has even gained more than 3 percentage points from its March 2020 low of 0.3%, to 3.5% at the time of writing of this article. France’s 10-year rate has been no slouch, gaining 2.8 percentage points from a low of 2.3% in 2020, as has Italy’s, which has tripled in 6 months to over 4% now.

In just two years, nearly 7 years of a downward trend in long-term interest rates have been erased against the backdrop of exploding inflation and accelerated monetary tightening by the world’s major central banks. In fact, 10-year rates in major Western powers (the US, the UK, the eurozone, Canada and Australia) are on average close to their 2014 highs. “What if this (recovery process) was just the beginning?” asks Véronique Riches-Flores, founder of RichesFlores Research.

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US 10-year rates: what does the technical analysis say?

From a technical analysis point of view, the US 10-year rate is a dangerous model. In fact, last June it surpassed the major peak of October 2018 (3.26%), which was an important resistance until recently. It is now in a hurry to attack the resistance of 3.50% (peak in June), a breach of which would open the door for a continuation of the upward movement, with a target of 4-4.02% (major resistance) in the medium term in eyesight.

The 30-week moving average (the average, updated every week, of the closing prices of the last 30 weeks) plays the role of dynamic upward support. Bollinger bands (a measure of price volatility) suggest that the 10-year rate could soon take a significant turn, a priori upwards.

On the contrary, in the case of a relapse, a possible break of the very strong support of 2.51-2.58% on the 10-year rate would support downward acceleration.

US 10-year rates: developments and technical analysis Capital (investment data)

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Inflation should remain strong… and central banks tight, which should push long-term rates higher

From a fundamentals perspective alone, inflation may not fall as much as many market participants expect, which should keep long-term rates under pressure. 2 1/2 years after the COVID-19 crash, the major powers continue to deploy massive budget efforts amid the state of emergency in Europe linked to the war in Ukraine, the European Green Deal, the “anti-inflation” plan. Joe Biden, the recovery plans of China and Japan, and Germany, which wants to face the gas crisis… “Fiscal policy has never been so active”, notes RichesFlores Research in this regard.

“Energy vouchers, tax cuts, social benefits, a tariff shield, a rail tariff in Germany, the renewal of energy infrastructure and equipment… that’s what counts in the end,” assesses the design office, which emphasizes that Berlin “sat down on its budget principles.” In Europe, 2022 will be “the third year of the budgetary exception, during which the sums provided by governments to absorb risks are extraordinary,” he notes.

And in the United States, the program of Joe Biden’s law to reduce inflation (tax credits for the purchase of electric vehicles and low-carbon energy equipment) paradoxically has “every reason to intensify short-term pressure on prices”, judges RichesFlores Research, because this large-scale plan represents “immediate support of demand” (and therefore inflation).

On the labor market side, the “Great Resignation” (many employees choosing to leave the world of work) is contributing to labor shortages, which translate into recruitment difficulties and wage tensions, fueling inflation. We are also increasing the social minimums…

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As the causes of inflation become “more domestic than external”, according to RichesFlores Research, the surge in consumer prices is now forcing central banks to “act with greater conviction” and over the past six months the Fed, ECB and Bank of England (BoE) have “taken action in often unprecedented scale”.

From the stock market low point in mid-June, “markets were playing the rate cut an hour ago,” earning an extraordinary recovery by mid-August. But the rally has been in the wings for a month, on the back of disappointing remarks from the Fed (which reaffirmed its desire to end inflation at all costs) and higher-than-expected consumer price growth. . “The markets are not ready for a permanent and significant tightening of monetary policy. The risks of instability are increasing,” warns Véronique RichesFlores.

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Real long-term rates are likely to continue to rise

The strength of inflation should be more persistent than expected. And in Europe, the weakness of the euro (which automatically increases the cost of imported goods) does not help matters. Major central banks are expected to continue aggressive monetary tightening despite recession fears. Real interest rates (long-term rates, excluding inflation expectations) are likely to continue their upward trend, which is a particularly damaging phenomenon for the stock market, especially for technology or growth stocks, which are most sensitive to this phenomenon.

In such a context, the correction of world stock markets is “probably not over”, according to Véronique Riches-Flores, who emphasizes that the growth of real rates “implies significant sector rotations”. “Health care, luxury (personal goods) and industry are the most negatively exposed to such an outlook, while banks, media and, to a lesser extent, the insurance industry are better off in terms of their current valuation. “, states the expert.

RichesFlores Research (sources Riches Flores Research, Macrobond)

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Author’s statement of interests

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