I spent Wednesday afternoon refreshing the results of a government bond sale, which is not a hobby I recommend to anyone with social or romantic aspirations. It was worth it, and here is what I found.
Borrowing just got more expensive than at any time since 2007
The ten-year Treasury rate is what the U.S. government pays to borrow for ten years, and most other loans, including your mortgage, are priced off it. On Thursday it closed at 5.18 percent, the highest since July 2007. The average thirty-year mortgage crossed seven percent.
The spark was a bond sale on Wednesday. The government tried to borrow $70 billion for five years and got the weakest demand since 2018. When fewer people want to lend, the borrower pays more.
Stocks went up anyway, but only the famous ones. A handful of chip and AI companies lifted the S&P 500 about one percent. Most of the market fell, and the companies that borrow the most fell hardest.
Investors trust the Fed to beat inflation, and they are paying for it
Here is the part most of the coverage missed. When you lend someone money, you charge for two things: enough to cover inflation, so your money does not shrink while it is gone, and a fee on top for letting them use it. The government sells a special kind of bond called TIPS, short for Treasury Inflation-Protected Securities, whose payments rise with inflation. Comparing TIPS with an ordinary government bond splits the interest rate into exactly those two pieces. So I pulled both, month by month, for the whole year.
If this were an inflation scare, the inflation piece would have jumped. The war with Iran nearly doubled the price of oil, after all. It barely moved, and it sits almost exactly where it started the year. The fee did all the rising and now sits at its highest since 2008. That fee is the piece the Fed pushes around, and on September 16 the Fed raised its rate for the first time since 2023 and hinted at more. Lenders are calm about inflation because they believe the Fed will stop it, and the cost of that belief is expensive money.
Think of a moving company quote with two lines, the truck and the fuel surcharge. With oil this high you would expect the fuel surcharge to explode. It barely moved. The truck got expensive, because the only guy in town who owns a truck, the Fed, raised his day rate and hinted he might raise it again. Everyone moving this fall is paying for the truck.
Investors expect two more Fed hikes. I think oil decides it, and Iran decides oil.
The Fed's officials publish their own forecast, and in September it showed one more hike and then a long pause. Investors are betting on more. A two-year government bond now pays about a point more than the Fed's own rate, and a gap that wide mostly means lenders expect the Fed to keep raising. Add up what short-term bonds are pricing and you get about two more hikes.
The Fed is raising rates for two reasons, oil and a hot economy, and whether it stops at one more hike comes down to oil. The President said on September 22 he expects a deal with Iran right after the midterms, though days later he turned down Iran's latest offer. A deal that reopens the Strait of Hormuz would pull oil down and take away the Fed's main reason to keep going. The economy should also cool a little on its own. Company profits in the S&P 500 are on track to grow about 32 percent this year, helped by oil companies whose profits are nearly doubling. Analysts surveyed by FactSet expect that growth to slow to about 15 percent next year. Fifteen percent is still healthy, but slower-growing companies hire and spend a little less, and that takes some heat out of the economy without the Fed lifting a finger. We have also seen the Fed skip a hike it planned: in September 2023 it penciled in one more, and it never came.
Russia is the other war in the oil market, and it matters less for crude than you might think and more for diesel. Russia is still pumping about as much oil as last year, according to the government's Energy Information Administration, while the Strait of Hormuz has kept more than six million barrels a day off the market. What Ukraine's drone strikes have hit is Russia's refineries, the plants that turn crude into diesel. That is a big reason diesel cost $6.53 a gallon on September 21, up 74 percent in a year. The EIA expects the lost Russian refining to keep diesel expensive into the first half of 2027 even if Hormuz reopens, which is why, even with a deal, I still expect that one more hike.
Without a deal, the math changes. Oil stays high, prices keep rising at the pump and in the store, and a Fed that just promised to beat inflation cannot stop at one. That is where the market's two hikes come true.
Currently, I believe that if there is a deal with Iran, the Fed raises rates at most once more, and the top of its rate is 4.25 percent or lower on March 31, 2027. If there is no deal by the end of the year, it raises at least twice, to 4.50 percent or higher. It is 4.00 today.
A deal that reopens the Strait of Hormuz pulls oil down, the Fed makes the one hike it already told us about, then waits.
What this means for your money
If you save, rates are the best in nineteen years. A five-year Treasury pays about five percent. Held until it matures, the day-to-day price swings stop mattering. If a deal comes and the Fed stops at one more hike, rates this high may not last.
If you borrow, it stays painful. Mortgages above seven percent will not fall fast while the Fed holds its rate this high. One interesting tell: Berkshire Hathaway, the company Warren Buffett built, has nearly doubled its stake in the homebuilder Lennar since June, including about $349 million in the last two weeks. My guess is that it expects people to keep needing houses after this spike, and likes buying the builder while the spike makes it cheap.
If you own stocks, the cushion is thinner. At today's prices the S&P 500 earns about 5.2 cents a year for every dollar invested, if analysts' forecasts hold. A ten-year government bond pays 5.18 cents, guaranteed. Stocks still win over time because profits grow and a bond's payment never does, and S&P 500 profits are on track to grow about a third this year. Companies that grow fast with little debt come out ahead. Companies that live on borrowed money, like the utilities Dominion and DTE Energy, pay for higher rates.
Checking last week's calls. I said the S&P 500 would reach 8,000 by the end of the year. It was 7,650 then and about 7,740 on Friday, a quarter of the way there, and I still expect it. I also said oil would average $80 to $95 a barrel through next June. So far it is running above that, and it needs the Iran deal.
What I am doing with my own money
Nothing. I opened the ALAN portfolio page twice this week to stare at the pie, which I am told does not count as cardio.
- Nvidia40.0%
- CrowdStrike30.6%
- Tech index fund (VGT)11.4%
- AMD7.2%
- Microsoft3.6%
- Meta2.2%
- Apple1.6%
- Alphabet1.3%
- Mastercard1.0%
- Netflix0.9%
- Visa0.3%
Same eleven holdings, no buys, no sells. I buy what I think are the best companies in the world and hold them for years. Most of them hold more cash than debt, so higher rates cost them little. I will be honest about the risk, though. CrowdStrike and AMD, more than a third of my portfolio, are expensive today because of profits they are expected to earn years from now, and higher rates shrink what those far-off profits are worth today. I am holding them anyway, eyes open.
What would make me wrong
The Fed's moves do not follow the oil. If a deal comes and it still raises twice, the economy is hotter than I think. If no deal comes and it stops at one or none, the Fed blinked.
The inflation line on that chart climbs past this year's high. Then people have stopped believing the Fed.
The next bond sale goes as badly as this one. Then lenders are walking away from the U.S. government, which is a much scarier story, and I will say so here.
The oil shock raised prices. Beating it is raising the price of money.
Thank you
Thank you for reading. Keep holding steady. See you next week!
Disclosures
My positionsI own NVDA, CRWD, VGT, AMD, MSFT, META, AAPL, GOOGL, MA, NFLX and V. I do not own LEN, BRK-B, D, DTE or FDS.
The author's opinion, for education only, not personal advice. He owns some of what he writes about, never trades a named security within 5 trading days of publishing, and is not paid by any company he covers.
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