Investors are once again battening down the hatches, preparing themselves for rough conditions stirred up by the Fed’s weather system. The FOMC’s latest remarks, combined with last Friday’s strong jobs report, have convinced many investors that the first rate hike will happen in December.
Fed funds futures currently indicate a two-thirds possibility of a rate hike at the December meeting. In preparation, investors are moving money out of interest rate sensitive areas and into pockets of the market that do well with higher rates.
[Read: America’s Top Forecaster: Fed to Tighten More Than Expected in 2016] Perhaps most evident is the impact to the bond market. Yields have been rising across the curve. On Friday the yield on the two-year note hit its highest level in five years. Below we can see a similar effect on the longer-term, bellwether 10-year Treasury yield.
I’ve marked the last two rate catalysts with vertical blue lines. The move higher has been swift and strong, and is causing a reshuffling of positions. But broader dynamics suggest it won’t last.
Before getting into why the move higher is unlikely to be sustained, let’s briefly walk through the rotation that occurs when higher rates are expected.
When interest rates rise, the opportunity cost of every investment changes. Opportunity cost refers to the loss of potential gain from other alternatives when one option is chosen. As this happens, the return for bearing near-zero risk (Treasuries) rises. This has a tendency to push investors out of riskier assets they may have been holding and into safer alternatives.
This post was published at FinancialSense on 11/10/2015.
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