By Mary Anne & Pamela Aden
Interest rates have been on the rise. That is, bond prices have been declining. This is a rebound rise following a sharp fall in rates, and we don't think it will last long. Why? There are several reasons, but following are the ones that are most important.
Why rates will stay low
1. Deflationary pressures remain in the driver's seat. As long as that's the case, interest rates are going to stay relatively low. Japan provides a perfect example. They've had deflation for 25 years, and their interest rates have been near zero for 20 years. Deflation and low interest rates go hand in hand, and for now, there's no end in sight.
2. The debt is huge and it keeps growing. This is helping to fuel deflation. It's also why economic growth has been so slow. In the first quarter of this year, for example, GDP only grew at a .2% annualized rate. In other words, it barely grew at all.
3. This must have spooked the Fed and be the reason they didn't raise interest rates as many had expected. As the economy keeps dragging, the Fed has had to adapt. And the way things are going, it's unlikely they'll raise interest rates in the months ahead. The combination of deflation and slow growth nearly guarantees ongoing super-low interest rates. The bottom line is simple: The Fed cannot raise interest rates in this environment. On the contrary, if the economy doesn't pick up soon, the Fed may have to resort to another round of QE to get things moving again.
4. As you know, low interest rates have been great for the stock and real estate markets. This, in turn, has been good for the economy. With mortgage rates near all-time lows, real estate remains very attractive and affordable. Plus, home prices are still below fair value, meaning prices are headed higher. Low interest rates are also good for the government. Why? Because they get to pay back their debt at cheap rates, making the debt burden more bearable. This alone is an important reason why the Fed won't be in a hurry to raise interest rates.
Battered bonds are still bullish
5. Despite the recent decline in bond prices, the market remains bullish (see Chart 1A).
As you can see, the bond price is still above its moving average, signaling the major trend remains up. In other words, the decline so far is still a normal downward correction following the steep rise in bond prices in 2014.
Bond slide limited
Plus, the leading medium-term indicator ( B ) for bonds is now approaching the "bonds too low" area. This tells us the decline in bond prices may be near an end.
If so, then bonds will again head higher while interest rates decline.
