Yes, you read that correctly. The more considerable misconception in my view is the belief that quantitative easing has been a primary factor behind the expansion in this post-Covid bull market. Near universally, the investing world and media fret Q.E.’s end as a material negative. In my view, this is backward—Q.E. is deflationary and contractionary. Slowing Q.E. would be good and stopping it quite bullish. The United Kingdom’s economic growth accelerated when the Bank of England stopped purchasing assets in late 2012, as did the U.S. in late 2015.
Surprisingly, this view is fairly unique because its economics are well established. Simply, a steeper yield curve is economically beneficial—even the Fed holds that view. A wider yield spread contributes positively to Leading Economic Indexes (LEI) globally. And for a good reason: The yield spread—the difference between short-term and long-term rates reflects the profit banks can make on their next loans. The wider the spread, the more profitable lending becomes. Readily available credit is a critical component to economic expansion. Conversely, a flatter yield curve is a disincentive to bank lending.
Few disagree with the preceding. Yet, by buying long-term bonds via quantitative easing, the Fed has been flattening the yield curve.
Remember, while the Fed controls the amount of money in the U.S. banking system, it’s up to banks to lend available funds in order to grow the money supply. By flattening the yield curve, the Fed has been sapping bank eagerness to lend, limiting the amount of new money flowing through the broader economy. By slowing or ceasing Q.E. bond purchases, the Fed would allow long-term interest rates to rise, increasing banks’ potential operating profits and encouraging lending. This would be bullish.
Some fear rising interest rates would weaken demand for loans. However, since long-term rates are still near historic lows, they can rise a fair bit and still be relatively benign. Further, many who would want loans now are effectively shut out because banks prefer to lend to those with pristine credit ratings since net interest margins are skinnier than they should be. Wider net interest margins should increase bank appetites to lend to a wider swath of folks.
Another concern is rising rates will increase America’s debt interest costs. As I’ve discussed in the past, America’s debt interest cost relative to GDP is historically low and approximately half what they were during the bulk of the 1980s and 1990s bull markets. It’s key to remember higher interest rates impact newly issued debt only. Further, short-term rates are still exceptionally low and haven’t budged much, and higher long-term rates won’t impact total debt interest cost.
Further, there is no evidence rising long-term rates are negative for stocks. 10-year U.S. Treasury rates increased, with volatility, from their low of 1.6% in 1945 to a peak of 15.8% in 1981. During that period, U.S. stocks annualized 11.1% (Jan 1941 – Jan 1981)—just about matching stocks long term annualized average. Nor are falling rates necessarily bad for stocks. From the 1981 Treasury yield peak to today’s relatively low yields, U.S. stocks have annualized 11.8% (Jan 1981 – Jan 2022). Simply put, there is no strong historical long-term relationship between stocks and bond yields.
Be bullish for 2022.