What If?

Reiterating again my bullishness on the economic agenda of the President elect of lower taxes and de-regulation (ex any nationalistic trade changes that include tariffs) I will repeat that it would be naïve to analyze this in isolation when trying to quantify the full implications. What if the 35 yr bond bull market is actually over? (I’ve been stating my case for a few months now). What will that mean for the interest rate sensitive sides of the US economy which would act as an offset to the impact of the upcoming tax and regulatory policies?

Let’s start with current US debt levels (I’m going to simplistically just focus on the US but we know a rise in interest rates will be a global phenomenon as it’s been so far with global debt at $152 Trillion). As of Q2, total US non financial debt (households, business and government at all levels) totaled $46 Trillion. That is 250% of nominal GDP. To compare, that ratio was 226% in 2007, 182% in 2000 and just 161% in 1983 when the US economy was then exiting recession. Thus, for every 100 bps increase in interest rates, we are talking about a $460b rise in interest expense (2.5% of GDP and use these figures when hearing about the size of any new fiscal policy). For the private sector, $27.5 Trillion of the $46 Trillion would see $275b of added interest expense. Directly speaking, I’m stating the obvious by saying activity in housing and autos will slow down in response to higher rates. By how much? I’m not going to guess because hopefully higher incomes will be an offset to some degree.

Where can interest rates go from here? We believe the 10 yr yield is headed towards where nominal GDP is potentially headed in the next few years which could be anywhere from 4-6% depending on how the US economy responds to this rise in rates. Is it possible not to have a recession with this kind of rate rise? Maybe but likely wishful thinking. We can all debate that but where would stock prices be if the 10 yr yield had a 6 handle on it? Still trading at 20x earnings?

Bottom line, lower tax rates and a hoped-for easing of the growing regulatory state will revitalize our economy I have no doubt. The only question is when do we feel the full effects. If it wasn’t for our massive debt load financed at artificially low interest rates for so many years, I’d say very soon but that of course is not the case. Be long term bullish but don’t ignore the interest rate pitfalls of getting from here to there.