Interest Rates. To Raise or Not…

As an equity & options investor, I often find myself looking at interest rates as a necessary evil… something I have to do, not because I want to.  Many colleagues get giggly over fix income.  But that disposition is dangerous as the rate (rise or not, how much, whatever, and wherever) has been and will likely continue to be the driver to equity pricing.  So powerful are low interest rates, that near zero has allowed many with finance degrees (think CFO suite) to engage in engineering beyond fundamentals.  Buybacks soar, investment plummets, and growth is a pittance.  Yet equity prices grow to the sky… look at any indice!

Not to go back to the discussion of Duration, or that nearly a Trillion $’s have been eviscerated since Trump, today I ask what could be the driver to higher or lower interest rates that the market (media) is not looking at.  Or better, what will the effect(s) be in terms of winners or losers (i.e. our opportunity) if the FED and longer term rates rise, fall, or stay the same?interest-rates-comparative

The consensus view is for a .25% rate rise in December.  Many say that’s now priced into markets.  I’m not convinced in any of these outcomes.

We can’t know what the Yellen etal are about to do.  But can the US (the economy or the people) withstand a rate rise?  In the chart above, the US has the HIGHEST interest rates in the developed world (G10), courtesy Bloomberg and the US Treasury, and not only on the short end, but throughout Duration!  I found the chart shocking even though ‘I knew’ the US rates were higher.  And this is dated as of September 2016. Now the US is even higher!

us-dollar-index-historical-chart-2016-11-27-macrotrends

Value USD (5 yrs) courtesy Macrotrends

What does this mean?  The herd is probably wrong!  I’m not sure the US can withstand higher rates than the rest of the world and what would come of it.  Already the USD is higher than at any time in 10 years (chart above),  leading to tumbling US exports, higher imports, lower inflation.  Nightmare in FED speak, but I see current headlines on most of this.

But what is less obvious and where is news most quiet?  Housing HELOC’s! A WSJ subscription is required to see the full article, but I’ll share a few points:

Helocs, a type of loan that allows borrowers to withdraw cash from their house…require interest-only payments for the first 10 years, but then principal payments kick in for the next [10], 15 or 20 years.

Roughly 840,000 Helocs taken out in 2006 are resetting this year, with principal payments on an additional nearly 1,000,000 loans expected to hit in 2017.

Helocs in early 2006 were at least 30 days late on $2.8 billion of balances four months after principal payments kicked in this year… 4.4% of the balances on outstanding 2006 Helocs. Delinquencies were at 2.9% before the reset.

Resets can lead to payments jumping by hundreds, or in some cases, thousands of dollars a month.

Bank of America, the largest home-equity lender by volume, reported $250 million of Helocs that had transitioned to requiring principal payments were at least 30 days delinquent in the second quarter, up 56% from a year prior… that accounts for just 2% of Heloc balances that are in repayment.

At J.P. Morgan, $647 million of Helocs that reset were behind on payments in the second quarter, up 21% from a year prior…

At Citigroup, delinquent balances totaled $338 million in the second quarter, up 105% from a year prior.

Interest rates rise, these payments & liability soar.  Could/should this temper an ambitious FED in rising rates?  Could/would this cause the next housing catastrophe?