Biden's budget assumption: interest rates might actually be "higher for longer"

David_Snowball

From the Wall Street Journal's analysis of the economic assumptions released with the Biden budget:

Economic forecasts released Monday as part of the White House’s 2025 budget proposal assume that three-month Treasury bill rates will average 5.1% this year, the same as in 2023, before declining to 4% next year and 3.3% in 2026.

The White House sees the average 10-year Treasury note yield rising to 4.4% this year from 4.1% last year and then declining gradually to 3.7% by the end of this decade.

My recollection is that 5% is dead average for the 10 year note over the past century. Good news: I recall hearing it from Kai Ryssdal on a Marketplace podcast. Bad news: can't track it down.

Those sort of interest rates remind investors that there is an alternative to stocks, which might well occasion a shift from equities and at least the tiniest bit of discipline on the part of managers (fund and otherwise). Jon Sindreu at the Wall Street Journal published an interesting project that suggests that cash might handily beat stocks over the next 12 years and would be pretty competitive with them over the next couple years. His projection of asset class returns, based on "quarters similar to today," puts the two-year APR for stocks at 7.something percent, cash at about 7% and bonds at over 8%. The dominance of stocks would return unless you had a time horizon of five years or more ("How to Invest? More than ever, it depends on who you are?" Wall Street Journal, 3/15/2024)

msf

My recollection is that 5% is dead average for the 10 year note over the past century. Good news: I recall hearing it from Kai Ryssdal on a Marketplace podcast. Bad news: can't track it down

TheMarketplace piece was actually written by Sabri Ben-Achour, though read by Kai Ryssdal. At the 2:15 mark (or in the text) you'll find:

“You know, actually, historically speaking they’re not that high,” said David Krause, emeritus professor of finance at Marquette University. He pointed out that on average over 100 years, long-term Treasury yields were 5.2%. Close to where they are now.

https://www.marketplace.org/2023/10/23/why-are-bond-yields-so-high-right-now/

I'm still trying to harmonize the second piece mentioned in the OP (by Jon Sindreu) suggesting cash yielding 7%/year over the next two years with the first piece quoting White House economic forecasts for cash (3 mo. Treasuries) averaging 5.1% this year and 4% next year. Even if that forecast is a bit rosy (costing the Treasury less in interest), I don't see how one gets to 7%, not just in the near future (next few months) but sustained over a period of two years.

Reading the 3/14/2024 online version of the WSJ piece I don't find mention of a two year timeframe. It does say that looking at quarters similar to today, " On a one-year performance basis, stocks weren't just riskier, they also returned less on average than bonds and cash." Print version must have more, or is at least different.

David_Snowball

The print version had two bar charts with returns over five or six time frames, both for all periods and after "quarters like this." The first three data points were one-, two- and five-year periods.

Thanks for the show notes. That had been bugging me.

As to the difference between "cash" and the interest rate, I failed to check the definition they were using for the asset class. It might be that ultra-short bonds are including and providing a bit of leverage. In a misplaced impulse toward tidiness, I think I recycled that edition of the paper already. (sigh)

Low_Tech

David_Snowball said:

From the Wall Street Journal's analysis of the economic assumptions released with the Biden budget:

Economic forecasts released Monday as part of the White House’s 2025 budget proposal assume that three-month Treasury bill rates will average 5.1% this year, the same as in 2023, before declining to 4% next year and 3.3% in 2026.

The White House sees the average 10-year Treasury note yield rising to 4.4% this year from 4.1% last year and then declining gradually to 3.7% by the end of this decade.

My recollection is that 5% is dead average for the 10 year note over the past century. Good news: I recall hearing it from Kai Ryssdal on a Marketplace podcast. Bad news: can't track it down.

Those sort of interest rates remind investors that there is an alternative to stocks, which might well occasion a shift from equities and at least the tiniest bit of discipline on the part of managers (fund and otherwise). Jon Sindreu at the Wall Street Journal published an interesting project that suggests that cash might handily beat stocks over the next 12 years and would be pretty competitive with them over the next couple years. His projection of asset class returns, based on "quarters similar to today," puts the two-year APR for stocks at 7.something percent, cash at about 7% and bonds at over 8%. The dominance of stocks would return unless you had a time horizon of five years or more ("How to Invest? More than ever, it depends on who you are?" Wall Street Journal, 3/15/2024)

I wish the White House (or anybody else) a lot of luck trying to predict where interest rates will be a year or two out.

I also recall hearing, years ago, that the long-term average for the 10 year Treasury being around 5%, but I know I didn't hear it from your source.

I have to laugh, or maybe yell, at young people today whining about 6-7% mortgage rates (which are also normalized, if memory serves). I bought my first house in 1975 and paid 8.5% which was the going rate. It went up into double-digits a few years later.

Maybe the era we're in with "high" (normalized) interest rates will encourage young people to not borrow so much, and instead try to live more within their means. I learned that valuable lesson from my father, who was a struggling young man when the Great Depression hit. Most people today cannot comprehend what those people went through.

As for cash being competitive with other asset classes, I have about 11% of my retirement portfolio in a 5.2% money market, which makes for a nice stable portion, yet still earning something -- unlike it would have a few years ago when "cash is trash."

Old_Joe

@Low_Tech:
Yes.

Baseball_Fan

Fiscal and monetary policies have consequences...many are getting what they voted for good and proper

David_Snowball

It would be prudent not to pursue this line is argument. The situation is complex and multi-faceted, neither of which tends to be reflected in social media posts. The on-topic lines of argument might be (1) will the "higher for longer" actually play out and (2) if so, how might investors best respond to the challenges and opportunities it would entail?

Baseball_Fan

hmm. I'll refer to a Occam's razor...something like that other things being equal, the simplest explanation is preferable to one that is more complex or simpler explanations are generally better than more complex ones...but let's stay on point as mentioned above....

I would be and am looking hard at BUFBX Buffalo Flex Income and RSINX Victory RS Investors funds...the former has many energy related stocks which are starting to break out and the latter has many energy and food stocks as well as insurance stocks...should do very well in a continuing inflationary environment....

Kind Regards,

Baseball Fan

msf

Einstein (among others): Everything should be made as simple as possible, but not simpler.

How about callable bonds or CDs? If interest rates stay higher, longer, then they won't get called and you may be able to eek out a slightly higher yield that way. The question is how much you are willing to risk.

Last Dec I bought a small 9 mo CD, callable in 6 mo, in my inherited Roth IRA. That was money dedicated to this year's RMD. Interest rates had been declining since Sept 2023 and this CD had the best return I could get. No big loss if rates continued declining and it got called in June. But it seemed that expectations for rates to continue falling decisively were overblown.

Right now, that CD is quoted at $100.02 - no increase in value. That's why one doesn't buy brokered CDs expecting liquidity. But they're fine for targeted purposes (like a Q4 RMD). Getting one that is callable can be a reasonable bet if one is expecting "higher for longer".

Derf

@msf "Right now, that CD is quoted at $100.02 - no increase in value." If the CD was called , how did you come up $100.02 ? Also, last Dec would be 2022 ?
Thank you, Derf

msf

Dec 2023, matures late Sept 2024, callable (with interest) late June.

The quoted price is the price I would get on the secondary market. A bond usually won't get called if it is trading below the call price. For example, a bond callable at par won't get called if the issuer can buy back the same bond on the open market at $99.

CDs are a bit different because there really isn't a functioning market. Quotes are fire sale prices. You might find a seller desperate for cash. Otherwise no one would offer the CD at the price quoted.