Just recently we have experienced what might possibly be the start of the reversal in a 30 year trend. For over 30 years, interest rates within the United States have been slowly but continuously dropping. From a cyclical high of a 15.8% yield on the 10 Year Treasury reached in 1981 to the incredible low yield of 1.63% reached earlier this year. While it was not a straight line and there were many counter-trends up, during the life of a 10 year bond you were guaranteed to not only earn a yield in interest, but to also earn a yield in principle. The constant and inexorable motion of the lowering of interest rates meant that it was always going to be easier in the future to pay of one’s debts- even if the only choice was to refinance the operation. Coupled with a constant and always positive rate of inflation, it made sense during the last 30 years to always try and leverage any activity as much as possible, continue operations until interest rates and inflation reduced the debt burden, and finally reap a return due to the equity growth in the balance sheet. The only issue that limited incredible rates of leverage was the ability to handle a short term reversal (remember Long Term Capital Management?).
That may have all changed earlier this year. The interest rate on the 10 year bond started rising from a low of 1.63% to just under 3%. And it seems that the positive change in interest rates, while large and quick, isn’t going to be stopping anytime soon. In fact, this change might be the harbinger of a long 30 year counter trend where rates inexorably rise and there is a constant and continued reduction in operational viability due to ever increasing financing costs. (Note: The wording in the earlier sentences intone a strong sense of conditionality; this isn’t meant to imply that the result or effect is in question, but that right now no one knows if this is actually the start of a counter-trend or just a false uptick to lower overall interest rates. While people may say that there’s very little room left for rates to fall, a valid counter example is Japan where rates have fallen to well below 1%.)