The Stealth Interest Rate Increase

Last update on: Jun 15 2020

I’m going to be busy at the MoneyShow Dallas this week, so I prepared this week’s update a day early, on Wednesday. Next week we’ll be on the regular schedule.

People are focusing too much on the Federal Reserve and when it might raise interest rates. That’s caused them to miss the rate increases that already occurred.

While the Fed dithered, Libor (London Interbank Offered Rate) has been rising since the end of 2015. The U.S. dollar three-month Libor increased from 0.33% a year ago to 0.88% without central bank action. Libor was 0.76% on Aug. 1. That gives the three-month Libor about the same yield as the two-year Treasury note.

Some of the increase occurred because investors expect the Fed to raise rates again at some point. The prime reason for the increase in Libor is the change in money market fund regulations, which we covered in Retirement Watch during the last couple of years. The regulations caused many investors to change from general, or prime, money market funds to U.S.-government-only money market funds. That forces non-government borrowers to offer higher interest rates to attract investors.

Libor is important because the interest rate on most variable-rate debt is based on Libor, and most derivative contracts and similar instruments are based on Libor. In addition, most non-U.S. banks use Libor-based short-term debt to fund loans and other activities that are based in U.S. dollars. The higher Libor increased the cost of doing business. Lenders will probably pass that increase on to their customers. But the higher costs increase business uncertainty and could derail some investments.

The higher Libor also is likely to cause investors to sell some assets purchased earlier this year. You might recall that when the European Central Bank and Bank of Japan increased their monetary stimulus earlier in 2016, those policies didn’t fuel higher stock and lower currency prices in Europe and Japan as intended. Instead, they increased U.S. asset values. Those asset purchases were hedged back to the home currencies of the investors. Because of higher Libor, the transactions are less profitable and perhaps unprofitable, so they are at risk of being reversed.

The increase in Libor is the largest increase in short-term interest rates since the financial crisis and is higher than what the markets have priced in for Fed rate increases. The increase hasn’t received much attention, so many investors and businesses probably are slow to realize it and factor it into their decisions. This is one reason U.S. stock indexes have lost ground since reaching record highs in August. It also is another reason to be cautious about most markets at this point.

The Data

Retail sales increased sharply in September, following declines in July and August. That’s why it’s important not to read too much into a month or two of retail sales reports. It’s a volatile number in the short term. The 0.6% increase in September brings sales over several months back to what they’ve averaged since the financial crisis. It shows that household demand remains solid. It is the strongest part of the economy and is likely to continue propelling growth for months to come.

There’s more evidence that we’ve seen the low point in inflation for a while. Producer Prices rose 0.3% for the last month and 0.7% for the last 12 months. Excluding food and energy, Producer Prices rose 0.2% for the last month and 1.2% for 12 months.

Also, the Consumer Price Index rose 0.3% for the month and 1.5% over 12 months. That’s the biggest increase in five months. Excluding food and energy, the Consumer Price Index (CPI) rose 0.1% for the month and 2.2% over 12 months.

The manufacturing sector continues to report mixed news. Industrial Production rose a modest 0.1% in the last month, while the manufacturing component rose 0.2%. But last month’s report was revised down to increase a negative 0.4% in each of those categories to negative 0.5%.

The Empire State Manufacturing Survey was a negative 6.8. This is the third consecutive negative month for the survey. The details of the report weren’t all negative, so it can be classified as mixed.

Consumer sentiment, as measured by the University of Michigan, took a dive in the mid-month flash report. It declined from 91.2 to 87.9 and is at its lowest level since September 2015. Most of the decline was due to less optimistic expectations. Most of the current segments of the report were positive.

The new home market still is strong, according to the Housing Market Index from NAHB. The index was reported at 63. That’s down from last month’s 65, but last month had an unusual five-point surge. Home builders remain optimistic.

Housing starts appeared to decline significantly if you look only at the headline number. But the decline was in multifamily housing and supports the optimism of the home builders. Single-family home starts increased over 8%, and new permits to build homes in the future also increased. This should lead to higher new home sales in the future.

The Markets

The S&P 500 is up 0.13% for one week as of Tuesday’s close. The Dow Jones Industrial Average returned 0.09%. The Russell 2000 declined 0.86%. The All-Country World Index rose 0.22%. Emerging market equities increased 0.73%.

Long-term treasury bonds returned 0.02%. Investment-grade bonds rose 0.48%. Treasury Inflation-Protected Securities (TIPS) increased 0.54%. High-yield bonds rose 0.21%.

The dollar rose 0.28%.

Energy-based commodities lost 0.39%. Broader-based commodities gained 0.63%. Gold gained 0.58%.

Bob’s News & Updates

Do you need gift ideas this year? Consider joining those who gave family and friends copies of the second edition of my book, “The New Rules of Retirement.” It’s the ideal, most up-to-date guide to any stage of retirement planning, even for those who’ve been retired for years. To receive signed copies at $25 per copy, send a check to Retirement Watch, LLC, P.O. Box 222070, Chantilly, VA 20153. We pay the shipping. Include your return address and any instructions about how to dedicate any books I sign for you.

Some Reading for You

New rules from the government mean doctors and others who serve Medicare beneficiaries are likely to make changes in coming years.

People who earn more money have more day-to-day stress than others, according to this report.

Here’s a review of the new money market fund rules.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.

 

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