There will be a new incoming administration next week and there are going to be a lot of changes in short order. We are going to have an overhaul of border policy, trade tariffs, pentagon, CIA, FBI and many other areas in the next several months. However, the one department that will likely remain steady is the Treasury Department and fortunately the hearing for the incoming Secretary, Scott Bessent, went very well. I expect to see Bessent in the media quite a bit in the coming months as he recommends budget cuts to Congress and will have to deal with refinancing over 40% of the Treasury debt in the coming year.
The Treasury Market
Unfortunately, prior administrations have the bad habit of refinancing mostly in the front-end of the curve and I expect that Bessent will want to spread more bonds to longer tenors. The risk to government is that the federal budget is impacted by short-term swings in interest rates (controlled by the Fed) so it is good policy to ‘ladder’ maturities across the spectrum. If there is ever a surplus in the budget, the Treasury can always buy back bonds in the secondary markets (don’t hold your breath).
Below, I have a chart of 10Yr Treasury yields which are the benchmark for longer tenors as it has the best liquidity (traded by many). I have modified my outlook from the previous posts of this chart as the recent move higher in 10Yr yields opens the possibility that there is another new high on tap up to the 5.25% to 5.5% range.
Once this pattern completes we will see a drop in yields closer to 4% (maybe in 2026). I expect to confirm this pattern once we see 10Yrs cross above the previous high. So, there may be a good buying opportunity in 10Yrs if this plays out like I have outlined above. Stay tuned!
We Are Not Alone
Interest rates have risen across the globe as you can see in the adjacent chart. Budget deficits and inflation are causing bondholders to demand higher yields until there is greater clarity on government spending and inflation.
Higher rates will put pressure on growth as more government revenue is used to pay interest on their debt loads which opens the possibility of a doom loop unless policy changes. Keep in mind that this will be a massive change for some European countries that had their debt trading at negative yields just a few years ago!
The Stress of Higher Interest Rates
The next few charts I pulled from a report by Elliott Wave International that highlights some of the issues we are facing in the current economy. To the right we can see that credit card defaults are rising as the American consumer currently has a savings rate of 0%. We haven’t seen a level this high since 2010 which was a byproduct of the financial and housing crisis of 2008 (lagged effect).
There is also a rise in corporate bankruptcy filings which is at its highest level since 2010. There will be a wave of debt to refinance in the corporate world in the coming three years so this will be another challenge for the incoming administration and capital markets.
It is likely many issuers will consider convertible debt but that has the potential to create a dilutive effect on their publicly traded stock. This is more likely to be seen with below investment grade companies and will cause pressure on parts of the equity market.
The Stock Market
Two more charts for you and be sure to see the last one below. The immediate chart below is of the S&P 500 and you can see there is a resistance level (yellow line) around $600 which has acted as a barrier since October. There is also a break of the trend line (white lines) and that could lead to a larger pullback in the coming weeks. However, the price action into the close on Friday does provide some evidence we will be seeing higher prices in February.
This final chart below is for historical perspective and it shows the S&P is trading at very elevated levels based on book values and dividends. There may be a good argument that technology is providing a boost to intangible assets (artificial intelligence) which are being valued more than the hard assets or book value of a company’s market capitalization. And there is quite a bit of money being made in technology but keep in mind that a good chunk of that cash flow is recycled back into share repurchases.
In either case, it leaves the indices vulnerable to a change in how the mega-cap companies are valued especially when interest rates keep rising like we are seeing with the 10Yr above. Valuations benefit when interest rates are low and the markets are flooded with liquidity which is being reversed with the current Fed policies not to mention eliminating the current US budget deficits. So, changes are coming and 2025 will be a year of many changes.
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Paul J McCarthy III CFA
President, Kisco Capital
