Are global interest rates destined to skyrocket in 2022? As inflation surges across many Western economies, the ECB, the Federal Reserve and other central banks seem ready to “tighten” monetary policy. So recently rising long rates may seem set to spike. Many observers, pundits, economists and investors fret about major economic and market fallout if they do. If that held true, China would suffer from tanking export demand. But don’t sweat over it. As temporary price pressures wane, long rates will shock everyone and end 2022 about where they began — whether central banks “tighten” or not. And even if yields rise, the impact won’t match the fear.
While headlines shriek of long-lasting inflation, still-benign long rates show that the forces now stoking prices are temporary. If they weren’t, long rates — which reflect inflation expectations — would surely have soared long ago. Yes, outside China’s sideways drift, rates have bounced higher in most major countries. But consider the levels. In the U.S., 10-year Treasury rates jumped from a paltry 1.51% at yearend to a still-paltry 1.75%. German rates? They rose from -0.18% to -0.03%, which many fret is “almost positive.” French yields rose from a miniscule 0.20% to 0.30%. Japanese yields more than doubled! But you need a microscope to see the rise from 0.07% to 0.15%.
Why haven’t yields jumped? Markets see what narratives miss: True, lasting inflation is broad-based. It is, as Nobel laureate Milton Friedman taught, a monetary phenomenon — too much money chasing too few goods. The recent, elevated inflation across most of the world is different. Beyond the energy crunch, it involves supply-chain snags, a function of the world’s intermittent lockdowns and re-openings aimed at quelling Covid’s spread. Temporary, renewed lockdowns like those in Xi’an notwithstanding, those snags are already abating. Container shipping prices are down markedly from last year’s highs. It is true the eurozone’s consumer price index climbed 5.0% year-on-year. But core prices, which strip out food and fuel, rose a far-slower 2.6%. U.S. core prices, at 5.5% year-on-year, also trail the headline 7% rate — and services prices are even slower, as they are relatively immune to supply chain pressures. January purchasing manager surveys showed prices cooling broadly in Europe and the U.S., too, as inventories recover.
The ECB and Fed’s cutbacks to long-term bond buying under quantitative easing (QE tapering) won’t jumpstart long rates, either. Now, QE did lower long rates. Bond prices and yields move inversely. The vast buying from central banks pushed prices up and long-term yields down. But remember: Markets pre-price all well-known information — and QE’s coming end is old news. Central bankers telegraphed tapering for months. Hence, U.S. 10-year yields fell by 0.04% between the Fed’s November taper and yearend, despite policymakers accelerating the taper in December. In Europe, Germany’s 10-year Bund yield fell immediately following the ECB’s September QE cut. Ditto for French yields. Markets pre-priced QE tapering long ago, then moved on. If less QE hasn’t already juiced yields, why would it now?
Many dismiss this, though, and argue looming 2022 short-term rate hikes from the Fed, the ECB and Bank of England will send long rates skyward. No. Consider the U.S. for its long data history. Since 1933, the median 10-year Treasury yield increases that occurred 6, 12 and 18 months after initial Fed hikes are 0.14%, 0.25% and 0.18%, respectively — tiny! Ten-year yields fell about a third of those historical spans. And, now, no one seems to have noticed that, so it has positive surprise power.
Why don’t long rates mirror short-term yield moves? Simple — long rates are market-set, moving on inflation expectations. Central bank-controlled short-term rate hikes aim to slow inflation. Markets anticipate and pre-price widely watched factors like central bank decisions. Always.
Outside China, global yields tend to move in lockstep. In the last 15 years, the correlation between U.S. and Chinese 10-year yields is just 0.15 — not significant, as 1.00 means identical movement and -1.00 exact opposite. That is probably due to China’s reforms on capital movement being relatively new and nascent. But British gilts have a 0.73 correlation to U.S. yields. German and French yields have 0.66 and 0.62 correlations to the U.S.’. Even Japanese yields have a 0.51 correlation to U.S. Treasurys. So, if you accept that America’s yields are unlikely to rise materially in 2022—and are possibly more likely to fall — know that this extends to much of the world.
What if I am wrong and the U.S. and global yields climb? Still don’t fear. Rising rates aren’t an economic threat to the U.S., the world or China. Since China joined the World Trade Organization in 2001, the U.S. long-term interest rates have seen a few persistent climbs. For example, from May 2003 through June 2006, 10-year yields rose from 3.37% to 5.14% (as the Fed hiked short-term rates from 1% to 5.25% — further proving long yields don’t parallel short). During this stretch, U.S. quarterly GDP averaged 3.6% annualized growth. U.S. imports from China grew an average 23.6% year-on-year. China’s economy, as you know, grew by leaps and bounds.
U.S. 10-year yields rose again from July 2012 to Dec. 2013, more than doubling from 1.47% to 2.97%. The U.S. GDP grew every quarter over this span, albeit by a historically slow 1.9% average rate — still creating increased demand for Chinese goods. In those six quarters, China’s GDP growth averaged 7.7% year-on-year. The U.S. imports from China grew an average 4.1% year-on-year, in keeping with the U.S.’ overall tepid economic growth and China’s shifting focus from export-led growth to domestic consumption.
As for stocks, many in the West have long claimed rising rates are poison. An old mythology — “don’t fight the Fed” — warns investors to stay out of stocks when rates rise. But it is bunk. In the U.S., the S&P 500’s correlation with 10-year yields is slightly positive — 0.33. The German 10-year and the DAX? Also 0.33. In France, the CAC 40’s correlation to 10-year yields is 0.15, while Chinese stocks and yields have a tiny 0.16 correlation. Modestly positive correlations reveal no set relationship between long rates and stocks — nothing to drive portfolio decisions. They certainly don’t support the theory rising rates kill stocks.
Fed rate hikes don’t sink stocks, either. The Fed has launched 10 rate hike cycles since 1971. In the 12 months after the first hike in each, U.S. stocks averaged 6.9% gains. They rose after 8 of 10 initial hikes. Similarly, 24 months after the first hike, U.S. stocks averaged 19.3% and rose 80% of the time. This doesn’t mean you should ignore central banks altogether. When they err, it can cause big fallout. But most of the time, they are simply reacting to conditions — they aren’t creating them. Rate hike cycles normally begin because the Fed is responding to a growing economy increasing inflation pressures, so they see less need for “stimulus.”
So don’t let rising rate goblins scare you in 2022. For one, rising rates aren’t likely to materialize. But even if they do, it won’t be bad for stocks, China’s growing economy or the world’s.
Ken Fisher is the founder and executive chairman of Fisher Investments.
The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.
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