A seesaw visually represents the inverse relationship between interest rates and price. As interest rates rise, fixed income prices (e.g. bonds and notes) fall, and as fixed income prices rise interest rates fall.
The Federal Reserve only has direct control over short term rates as a lever to stimulate or slow the economy. The dual mandate of low unemployment and adequate inflation are the data points that they depend on.
Long term rates for the highly watched ten year note are determined by supply and demand. That buying and selling for distant maturities shapes the yield curve steepness.
Interest rates are essentially at zero for short term funds, while the 10 year note hovers around the 2% level after historic lows in the last years.
Seemingly it was not a matter of if rates will rise but when A negative interest rate environment is not unheard of with some willing to pay to have the perceived safety of fixed income.
Extreme demand for treasuries in an environment of uncertainty would drive up price and depress yield as those who want the full faith and credit of the United States would sacrifice return rates.
The lack of reasonable returns has made the equity market a choice for many in the chase for investment yield. A normalization of interest rates, whatever that may mean in the future, could spur demand in fixed income but drive down the price.
Here are two points I want you to think about:
- Higher interest rates eventually make fixed income investment an alternative to equities but realistically only when rates rise to at least the S&P dividend of 2% plus.
- Safety buying of treasuries push up price and knock down the yield return.
Ride the seesaw with caution, because what goes up must come down.
