Banks, Interest Rates & Bonds

Interest Rates

If you didn’t know better, you’d think the US Treasury bond was sucking all the oxygen out of the room. A couple of banks have failed, in part because the US treasury pays more interest on short term notes than banks can afford to pay on deposits. Some banks have seen deposits move out very quickly and have gone from being (almost) adequately capitalized to Out of Business in the course of a few weeks.

Oh well. That’s the flaw in fractional banking: Anyone who is a customer at a US bank can basically have all their money, right now. But Everyone ​ who is a customer at the bank cannot have all their money right now. And if they all show up at the same time, it’s not a wonderful life.

That’s the flaw in fractional banking: Anyone who is a customer at a US bank can basically have all their money, right now.

Whatever. That’s not a banking crisis; that’s banking.

Occasionally banks fail. If we had a system where banks never failed, or corporations never defaulted on debt, we’d have a system that took too little risk.

The main thing is that the existing system can absorb these losses. It’s bad for the shareholders of the bank; pretty good for the rest of us who want to believe our funds are safe when we entrust them to custodians.

The main thing is that the existing system can absorb these losses.

The US Treasury

The treasury yields probably are too high– relative to the rest of rates. In other words, either bank deposit rates will have to move up to near treasury yields, or eventually treasury yields will come back down.

Our credit system isn’t built for an inverted yield curve, where short term rates pay out more than long term rates. For now, we have have an imbalance as the Fed tries to fight inflation. Likely, one of two things will happen: either the economy will weaken further, lowering inflation and eventually interest rates. Or, the economy will keep on doing what its been doing– which is delivering weak, but surprisingly good growth under the circumstances and rates may stay up for longer than the market expects.

Our credit system isn’t built for an inverted yield curve, where short term rates pay out more than long term rates.

Will the US treasury default on the debt? Well, if you asked yourself if there are MORONS running congress, Mitt Romney would say: yes. But the other question is: can a handful of these nincompoops can drive the whole train off the tracks?

We’ve seen this story before in the debt debates.

Don’t forget: being elected to Congress is getting to decide how to spend money. Not: how to not spend money. Governing is different from politics. Some people don’t know this. The system does know this. If you crash the system, you forfeit your right to govern. That’s not what’s happening. What’s happening is a negotiation over spending and overpower. That’s the game. Play on.

Don’t forget: being elected to Congress is getting to decide how to spend money.

Earnings

This is probably the 5 th straight quarter in which economist and analysts worried that the Sht was abt to Ht the Fn.

But that hasn’t happened. Even the banks and techs largely beat negative earnings expectations. The consumer is still consuming!

Even the banks and techs largely beat negative earnings expectations.

So, here we are muddling along, stocks stronger than expected, the economy ok, everyone worried about the next quarter’s earnings. Sure looks like the soft landing to me.

We do expect that earnings will be weak the next few quarters. But we don’t know that. In my experience, the market surprises to the upside more than the downside.

And this is why the main point of planning is to describe your relationship to risk: how much should I maintain? How much stock exposure should I have? If you get that right, you don’t have to guess right about the short-term direction of the market.

And this is why the main point of planning is to describe your relationship to risk: how much should I maintain?

Bonds

Unless inflation really goes hard the other direction, treasuries– including long term treasuries– look to be a good value. These are pretty much the best interest rates we’ve had in a decade.

Now, while rates are still rising, and while we’re still fighting inflation, bonds may not hedge stocks as well as they have historically. But I think that’s a shorter-term problem, one easily solved by also holding cash paying 4% interest rates.

Now, while rates are still rising, and while we’re still fighting inflation, bonds may not hedge stocks as well as they have historically.

But I think your average person would do well to shift some of that cash to longer maturities. That strategy is likely to work if the economy does go into recession. High quality bonds have more volatility than normal. They’re also a better value than they have been in a long time.

Jeremy L. Strickler, CFP®

Portfolio Manager

Portfolio Manager...

This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer.

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