Why is the Fed so eager to raise rates?


I’m a little bit confused by the latest interest rate hike move by the Fed and forecast of two more bumps up this year.

It seems bizarre in my opinion, and I am completely shocked by that.

Ten-year rates hardly budged after the news on June 13, basically finishing the day at 2.97 percent.

However, the two-year bond rate did end higher at 2.57 percent.

 

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Conflicting Trends

In my view, a game of chicken is being played out right now between the Fed and the market.

The Fed’s actions are raising the front end of the curve. However, the long-end of the curve seems to be signaling that inflation will remain in check.

So why is the Fed choosing to be so aggressive? I’m not entirely sure.

Look at the Producer Price Index (PPI), which was just over 3 percent as of June 14. But also look at it as it relates to oil.

 

Inflation Outlook

As I’ve predicted before in my market commentaries, I think that 0il prices are heading lower, probably to about $60, in the short-term.

To my way of thinking that means the inflation rate will come down–not advance up.  

In my opinion, part of the reason why the long-end of the curve will not rise is that foreign investors are buying our bonds.

Consider the substantial spread between US and German 10-year government bonds.

 

Takeaway

In my view, as long as the spread stays this wide, the long-end of the curve will not rise.

So who will blink first, the Fed or the market?

The dollar did not react to the Fed’s latest rate hike move.

But if the Fed is going to maintain an aggressive monetary policy and the foreign buyers are going to continue to flood the bond market, here’s what will happen in my view.

In my opinion, the dollar will appreciate against rival currencies, and that will keep inflation tame.

Photo Credit: FutUndBeidl via Flickr Creative Commons

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Mott Capital Management, LLC
Mott Capital Management, LLC
Mott Capital Management uses a long-term thematic growth approach to investing in equities. We search for investments that both reflect and help to shape generational and demographic shifts. Mott uses a philosophy of buying these companies for a 3- to 5-year time horizon, with the belief that a long-term holding period gives themes and our chosen companies a chance to fully develop. In our view, the long time horizon also serves to mitigate the risk associated with the short-term impact of market volatility.