Rising US Interest Rates - BVI Property Guide
by Adam Stauffer, CFA, Chief Investment Officer at Offshore Investment Advisor
In the last months of 2010, US Treasury rates—or the interest on US government debt—started to climb from near historic lows.
The combination of a second round of quantitative easing by the Federal Reserve and an extension of former US President George W. Bush-era tax cuts sparked a rally in 10-year Treasury rates from a low of 2.45% in early October to around 3.5% at the time of this writing.
While the prospect of rising rates is welcome news for investors in CDs, many of whom have realised negative real rates of return over the last several years due to near zero percent interest rates, the impact on short-term CDs will be muted. In fact, the benchmark three-month CD rate only increased to 0.29% from 0.27%. Instead, the primary impact will be felt in mortgage rates and more generally across an investor’s portfolio.
When you are a rapper named 50 Cent and you use Twitter to promote stocks in your portfolio: “Sales of the penny stock [ticker: HNHI] increased by 290 percent following the endorsement [by 50 Cent], resulting in a paper profit of almost $5.2 million for the rapper, who owns 7.5 million shares in the company...” To read the full article see “Is 50 Cent Using Twitter to 'Pump and Dump' Stock?”
Maybe James and I should hire 50 Cent to write this commentary …
In some ways it sure seems like it. Equities appear to be unstoppable and some names like YOKU and DANG have had IPOs that have skyrocketed in their first several days of trading similar to dot-coms in ‘99. In reality, 1979 may be more like it. But let’s hope it is neither!
What is happening in Egypt has some similarities to Iran in the late 70’s. In 1979, amid massive protests in Iran, the Shah fled and the anti-western Ayatollah Khomeini took over leadership. This set up the Arab oil embargo of the US and its western allies and set off an inflationary cycle in everything oil-related, from gasoline to food. The price of Saudi crude more than doubled to around $34 a barrel at the end of 1980 from $14 two years earlier. A similar disruption in the Middle East could send WTI crude oil, which currently trades around $90, well above its previous high of $145 in 2008 (see chart).
However, it is unlikely that Egypt will be the cause of a massive spike (at least directly), since the country does not produce much oil. Egypt does control the Suez Canal, which sees more than 5% of the world's oil pass through it, however even this is unlikely to set off an inflationary spike.
In my opinion, the bigger concern is how quickly these disturbances are spreading from country to country. According to Business Insider, what started in Tunisia “partially due to food price inflation and unemployment, but also because of WikiLeaks,” has spread to Egypt, Morocco, and Algeria, among other countries. If a serious disruption were to spread to a significant producer of oil then runaway inflation—starting in oil-related products then spreading to other commodities—could be an issue.
Coincidently, if you have been reading our past couple of Commentaries there is a scary, albeit loose and lucky, similarity between what we spoke about and what is going on. Specifically, in November, we mentioned:
“To cap off the negative tone for the month, Wikileaks has thrown a wrench into closed door politics and, in my opinion, has turned a nearly impossible situation in the Middle East into an impossible one…” Read more here.
Then in December we spoke tongue in cheek about Armageddon and commodities inflation:
“I am not an “Armageddon is coming” type person, but It is easy to let your mind get carried away when you think of how much food, energy, water, etc. 7 billion people need…” Read more here.
Bottom line: The current turmoil in the Egypt is not Armageddon (although if you live in the region then it may feel like it). However, food prices have been rising dramatically in the Middle East, as well as other parts of the world. According to the UN, the food price index is at the highest level ever recorded. This food inflation has the possibility of creating global social unrest (particularly developing markets), which generally speaking will have negative implications for stocks which tend to decrease in value during times of uncertainty and positive implications for supply constrained things like commodities. Furthermore, it appears that risks are starting skew in favor of holding developed equities vs. developing.
For more information on the linkages between the Mid-East unrest and Wikileaks and Food Inflation see here and here.
