Two near-term events may have the potential to wreak havoc on markets. They could also pass without much notice, especially given they are known events. I am referring to a potential Fed rate hike and the October 14th implementation of Money Market Reform (MMR). Both could create an uptick in other lending rates. Interest rates overall remain very low by historical standards but some markets have already started to adjust to MMR. Investors might want to recognize a Fed rate hike and implementation of MMR could stress parts of the fixed income market, especially those sensitive to Libor.
10-year Treasuries continue to rally but the trading pattern over the summer has changed character. Broken support at $111.25 may end up sending yields back to the 2% range. Yields on 10-year Treasuries are currently around 1.5%, just above the 1.3% all-time low this century.
Investors are left sorting through a variety of mixed signals. We continue to be told another rate hike is coming in 2016 if economic numbers continue to produce economic growth. This morning’s Purchasing Managers Index (PMI) was a disappointment so once again economic strength is inconsistent. Remember though, the Fed is not trying to slow an economy about to overheat with rate hikes, they are trying to normalize rates.
Near term the current wildcard is the combination of a Fed Rate hike and the impact of MMR on short-term rates and their ability to influence other parts of the fixed income market. Think about all the lending rates sensitive to short-term benchmarks. Not only is corporate cash management impacted significantly but an increase in loan costs could curtail other parts of the credit market as borrowers’ step away. That would be problematic for a credit dependent economy. Once again it’s shaping up to be a very interesting fall.