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Interest Rates Matter

The Recent Past

Predicting future interest rates is not easy, but with the global economy stalling and the US economy slowing the risk of rising interest rates is greatly diminished near term.  What is missing from most discussions of interest rates today is that our rates are affected by global forces primarily through the difference in our rates from the other developed economies. 

When the Federal Reserve was pushing interest rates up, this resulted in capital losses on Treasuries which subtracted from the US Treasury total returns bringing the total return on US bonds down to zero.

Once the Fed slammed on the rate hike brakes, capital losses were no longer a factor and you now had global investors comparing zero percent rates in Germany in Japan to the US interest rates over 3%. Money flowed into US Treasuries.This demand for US Treasury pushed prices up and interest rates came down. The US yield curve inverted a second time in part due to this global arbitrage.

The other part of the drop in rates is a global recession outside the US due in part to the trade war.  With the trade war escalating to an economic war, we are seeing a global flight-to-safety and US treasuries are the top global safe haven asset.

The one force that is pulling the other way today is the growing US budget deficit will provide a tremendous supply of Treasuries in the coming years.  This will pressure interest rates higher at some point. In the first half of 2019, the greater pull on rates was down based on safe haven demand.

Imported Global Insanity

The bottom line is US rates are being pulled down by a global market where European and Japan’s central bank are heavily engaged in the business of driving long-term rates down with money created out of thin air. 

Free markets do not produce negative interest rates and today in Germany you can lock in 0.2% annual losses for 10 years with a German Bund (bond).  And with 1.5% inflation, German savers will lose close to 20% of their purchasing power in 10 years.  Yeah negative rates!

Lock in your 10 year losses today

I will spare you my long rant on how central bank’s manipulating interest rates below inflation is basically a transfer of wealth from savers (pensions, life insurance companies, mom & pop) to financial speculators and real estate investors.  What is most disturbing today is that our monetary magicians are working on plans in the US for much more of the same even after its abysmal effect on the real economy the last 10 years...  To possibly include negative interest rates in the US.  Yeah financial repression.

What does this mean to us

From an investing point-of-view, this means the TSP F fund has about 13% capital gain potential if they drive rates all the way to zero.  But understand that once we hit zero, that is all you get from that time on.  Zero yield means zero yield.  Raising rates from there would result in capital losses.  I consider this madness, but it is the baseline scenario in the next recession -  the Fed Chairman just said so and he is making up excuses to go along with it.

Where are interest rates headed?

There are too many forces at play to provide one rule of thumb, but we do have some.

Jeff Gundlach uses a simple formula for estimating where rates should be.

He averages the (Nominal US GDP growth rate) and the (10-year German Bund) to come up with the estimated US 10-year bond rate.

If we use 4.2% for nominal GDP and -0.2% for the German Bund today, then the 10-year should seek around 2%.  Our 10-year’s recent low was 2.08%. In this scenario 1.8% to 2.2% makes sense.

If the US goes into a mild recession with nominal GDP at 1.5% and German Bunds at -0.5%, then the 10-year would seek 0.5%. 

If not for the central bank interventions overseas, the US 10-year used to simply chase the US Nominal GDP.  If we use 4.5% for nominal GDP (2.2% inflation and 2.3% real growth) then the 10-year would seek 4.5% which is where it looked like it was headed last year.  But with the global recession and central banks suppression, the trend in interest rates reversed sharply in 2019. I would also add wall street market makers started hoarding Treasuries last October which accelerated the drop in interest rates with the effect of halting the Fed's rate hikes.  Nice job wall street.

Expect a roller coaster ride in interest rates and the stock market 

US interest rates will retest their lows once the Fed starts dropping interest rates and this may be concurrent with a falling stock market. The 10-year Treasury could tag 1%.  A recession will result in blowout budget deficits and will then pressure interest rates higher forcing the Fed to heavily monetize the US budget.  Gold prices seem to be waking up to this possibility, but remember "paper gold" sets prices and they can create all the "paper" gold they want to sell to speculators.  

Corporate bonds will see rising default premiums meaning the TSP F fund (AGG ETF)  will not fully capture the gains from the drop in Treasury rates. A financial panic could result in the markets dislocating in many bond funds due to the panic selling of ETFs with no buyers other than sharks scooping up funds at large discounts to the indexes like we have seen several times in the last decade.

Non-TSP note: During market dislocations, Limit Orders should be avoided because they become Market Orders below limit prices. And those dislocated prices could be significantly lower than the last traded price. Here is an example of a short term market dislocation in popular index ETFs at the market open. The SP500 index opened down 5% and recovered... some of the funds tracking the SP500 opened down over 15% before recovering. Some stock ETFs have dislocated by 50% during the day.  These were highly liquid ETFs, so some illiquid bond ETFs could see dislocations of greater than 50% during panics.  Do not sell during these dislocation events. 

This is not an issue with mutual funds and TSP funds.  

Shifting Allocations have short term effects on interest rates

The trade war is simply pounding the global economy at a time of extreme stock market valuations.  If a bear market ensues then many investors will shift funds out of equities into bond funds giving interest rates another push down. So an undershoot to the rule-of thumb would occur during this time.

The flight-to-the-safety to the world’s reserve currency should continue this year. Another drop of 1% in US interest rates over the coming year is not out of the question under current circumstances implying another 5% bump in the TSP F fund price. 

We also note the Fed Chairman’s recent speech opened the door to future rate drops to the “lower bound”. The “lower bound” is another way of saying zero interest rates without actually saying zero interest rates.

Or maybe they are discussing how “negative” they think they can go before people pull their money out of banking system. 

Note: Unlike the Federal Reserve and talking heads in media, I think lower interest rates have lead to slower economic growth and not higher.  When Japan pushed into negative interest rates, their economy slowed and the safes sold out in stores.  

Fluid Situation

I can only put so much in a static document about a very fluid investment environment. 

I categorize today as a hostile investment environment and because of this, the low risk funds become more important than usual.  Even the safer bond funds like the TSP F fund and AGG ETF have some risk during financial stress that needs to be considered.

Stay away from high yield (junk) bond funds, corporate bond funds and stick to the Treasury funds whether playing it safe or trading on interest rates movements with long duration Treasuries.  

Only trade the TSP F fund during interest rate drops and return to the TSP G fund when out of equities.  And of course follow our market commentary and look out for our email warnings and updates. 

For your non-TSP accounts, I've listed a few funds below to consider at the bottom of this page.  If you have not read our broader Best TSP Funds and Allocations pages, you are welcome to take a look.  If you want our email warnings and updates for all the TSP funds, you can join our service today for as low as $75 annually.


A Note About Investing in Retirement

When most investors retire, allocations need to shift to low-risk funds for income production.

For this reason above all others, please do not leave TSP when you retire!  I am probably one of the few advisers who recommends considering moving your other retirement account funds to TSP to take advantage of the G fund in retirement (along with the low fees).  Yes you can do this.

Can you imagine your broker or bank telling you to pull money out of their account and send it to your TSP account where they lose fees.  Commission-based financial planners are likely to talk you into moving your funds to their accounts and products so they can manage them for you to make your life easier.  It is not just the adviser's fee that will cost you, it is the loss of interest income in retirement by not having access to the TSP G fund when you need to be in low-risk investments.  

Please don't move your funds.  You can do fine managing your own account.  If you do transfer your funds out of TSP, consider keeping the minimum amount in your account to keep your account open to allow you to change your mind later or to move back when you retire.

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It's getting interesting,

Michael Bond

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Compare this to the last two bear market which cost the stock market over 50%.

After earning my degree in Investment Finance, I joined the US Air Force and thus became a TSP account holder.  I never gave up interest in finance and continued to study the markets while serving. I discovered I had to do some unlearning from what I "learned" in my financial planning courses.  Through my website and blog I share what I've learned.

I spent years researching the best strategy for the TSP funds.  I wanted a strategy that was easy to execute and did not ride the bear markets down. I almost gave up then found Sy Harding's strategy which only required two trades a year and was rare in that it beat buy and hold over the long haul.  

Mark Hulbert of the Financial Digest fame tracked Sy's record and often wrote about him on Market Watch.  Sy invested in the Dow Jones Industrial Averages. I simply optimized Sy's seasonal strategy to fit our TSP funds.  

I also developed my own TSP almanacs which break down the annual patterns of the markets to the trading day of the year. On my website you will find a more in-depth breakdown than the Thrift Savings Plan's own website for each fund (to include the Lifecycle funds) to better understand what is driving their returns.  It all helps in determining the best TSP allocation.

I started my company in 2011 and my service in 2012.  I hope you have some time to look around the site - it is designed for you.  And did I mention you can also sign up for my free blog.  

Non-TSP accounts safe investments

Prime Money Market funds are a simple investment while avoiding most risk.

The IEI ETF which invests 100% in 3-7 year Treasuries comes with a slightly lower yield, but performs better in financial crisis thanks to that flight-to-safety effect. And yes, I recommend it over the AGG ETF in today’s environment. 

If you are betting on declining interest rates, then the IEF ETF provides larger price movements since it invests in longer duration Treasuries (7-10 year).  The TLT ETF gives you the largest price movements with 20+ Year Treasuries.

This website provides a commercial service and is not affiliated with the Thrift Savings Plan administration.  Recommendations are based on our best judgment and opinions but no warranty is given or implied.  Past performance does not guarantee future performance or prevent losses.   All readers and subscribers agree to this website's Terms of Use and Investment Disclaimer.   Copyright © 2011-2021 Ravenstone Research Inc.  All Rights Reserved.  


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