A Federal Reserve turned hawkish and a Treasury Department keeping bond markets well supplied have carried yields to their highest levels in seven years.
And at least one veteran investor says an economy that’s running very hot could lead benchmark interest rates much higher.
“I calculate fair value at around 4.5 percent in the 10-year,” Jack Ablin, founding partner and CIO at Cresset Wealth Advisors, told CNBC’s “Futures Now” on Thursday. “Historically the 10-year Treasury tended to track nominal GDP just as the overnight fed funds rate tends to track real GDP.”
A run up in interest rates could derail growth, making it more expensive for consumers to borrow while raising debt costs for companies.
By Ablin’s calculations, the real economic run rate at 2.5 percent and a 2 percent inflation rate brings nominal GDP to 4.5 percent. Ablin said the yield on the 10-year should be roughly level with that figure.
If that was to happen, the 10-year yield would soar to its highest level since October 2007.
Yields could spike to that level once global central banks move more aggressively to drain financial markets of excess cash. As it stands, the world’s policymakers have slowly eased out of crisis-era monetary conditions, keeping bond prices high and yields low by curtailing their bond purchases.
“We still have this crisis level monetary policy in the system,” said Ablin. “The European Central Bank is still putting money in buying bonds and the Bank of Japan is still putting money in buying bonds. In fact, there is still $6.5 trillion of bonds globally sporting yields below zero.”
The Fed, too, is still fairly dovish compared to its historical norm, even after hiking rates again in September. The effective fed funds rate at around 2.2 percent remains below the 60-year average of 5 percent. That has not kept President Donald Trump from lambasting the central bank as his “enemy,” and saying he was disappointed in the Fed’s policy.
Rising rates have spooked equity markets in October, a trend Ablin expects to continue. “It is going to put some headwind on risk-taking which of course has enjoyed ‘only-child’ status for the last 10 years,” he said.
The S&P 500 has rallied 315 percent during its nine-year bull run. During that period, the 10-year yield reached a record low of 1.36 percent.
“Higher interest rates will hurt for the same reason that these artificially low interest rates got people out from underneath their bomb shelters back in 2009 and actually tiptoed back into the housing market and the investment market,” said Ablin.
Ablin says a spike to 4.5 percent could occur quickly and unexpectedly, but his more conservative estimate is 4 percent by the end of 2019.
