With consensus being “lower for longer,” the decline in interest rates seems to show no sign of ending. However, as late 1981 shows, an end to a trend can take almost everyone by surprise…

 

It’s been all good news for stocks…

 

The November, 1981 interest rate for Canada Savings Bonds was set at 19.50%, shortly after the 10-year U. S. Treasury bond yield hit a record high of 15.84% on Wednesday, September 30, 1981.  By the weekend, yields had dropped and since that day “they have never looked back.”  Chart 1 graphically illustrates just how high interest rates had poked upward.   

 

Chart 1

 

As this blog is being written, the ten-year yield in the U. S. stands at 1.48%.  A recent Barron’s article dated September 22 chronicles the key timelines in this amazing bull market in bonds (as interest rates drop, bond prices rise).  Paul Volcker, the head of the Federal Reserve, had implemented a series of Fed Funds rate hikes in order to slow down the dramatic rise in the level of inflation during the 1970s and the first two years of the following decade.  In fact the Fed Funds rate, the interest charged by banks to lend overnight to one another, hit a high of 20% (see Chart 2) before “easing” to a current level of 0.09% forty years later.  

 

Chart 2

 

On November 28, 1983, with ten-year bonds yielding 11.6%, Barron’s Randall Forsyth wrote:  “One year into a business recovery, it’s being hotly debated whether inflation is down for the count or will come off the canvas.”  Just as today not many believe that interest rates can move higher, few thought then that rates would keep trending down.  While the insider trading scandal surrounding Ivan Boesky in 1986-87 helped push down the value of junk/high yield bonds, U. S. Treasurys continued their bull run (bond prices continued their move up) with yields approaching/dropping to 7%.  The Clinton-administration deficits of the early 1990s did nothing to “scare” interest rates skyward, as the 10-year hit a level of 6%. 

 

Even Pimco co-founder Bill Gross, who by the late 1990s was one of the biggest bond managers/bulls in the world, felt that yields would settle into the 6% range for an extended period of time.  In fact, the bursting of the dot-com bubble and 9/11 motivated the Federal Reserve chairman, Alan Greenspan (active in the role from 1987 to 2006), to drop interest rates on Fed Funds 13 times between May of 2000 to June of 2003 to 1.00%.  (Folks on Bay and Wall Streets were quick to point out in the 1990s and 2000s that if the stock market caught a cold, Dr. Greenspan would be quick to come to the rescue.)  Suffice it to say that the great recession of  2008-09 and more recently the sharp economic slowdown brought on by the pandemic brought swift action on interest rates and other monetary policy initiatives by central bankers around the world.

 

Rising interest rates in the 1970s and early 1980s engendered a pronounced foreboding that higher interest rates would again come back to upset the economic recoveries coming off the deep recessions experienced early in those decades.   Now, consensus is calling for low interest rates to persist well into the future, with many suggesting that the recent 4% inflation numbers are transitory.

 

A lot rides on this prediction, most notably that households will be able to continue to finance high mortgage levels with interest rates  at 2% and that governments will be able to continue to issue mountains of debt with impunity since their “cost of capital” is so low.  But any upward movement in interest rates also poses a major threat to stock prices, especially those in the high-valuation camp, and the financial viability of many highly levered companies that have recently made big borrowing a key to their strategy of growth by acquisition.  As always, the actions of the bond market have had a lot to tell us about the behaviour, and valuations, of the stock market.  Until very recently, the message of the former has been welcomed by the latter.