While U.S. economic data continue to come in mixed, the numbers still point to decent U.S. economic growth. That, along with some evidence of stabilization in international markets, has pushed the odds of a December interest rate hike by the Federal Reserve (Fed) higher. As a result, real U.S. rates have been climbing.
As I write in my latest weekly commentary, “Digesting the Implications of Higher Rates,” I expect the rise in long-term rates in the U.S. will be contained, given several factors, including demographic trends and institutional demand for long-term, high-quality bonds. But the fact that U.S. rates, both long- and short-term, are rising while rates are falling in much of the rest of the world has a number of implications for investors.
How Higher Rates Impact Investors
1. The dollar will continue to strengthen, keeping pressure on precious metals. Over the past six weeks, while U.S. rates have risen, rates have declined in Germany, Italy and Japan, according to data accessible via Bloomberg. Looking forward, we will likely continue to see a divergence between U.S. and international short-term rates as central banks in these regions maintain easy money while the Fed tightens. This rate divergence helps explain the renewed strength in the U.S. dollar, which last week reached its highest level since the spring, as Bloomberg data show.
The combination of a strong dollar and rising real rates is having a predictable effect on precious metals prices. The simultaneous rise in real and nominal rates reflects the fact that inflation is contained and that puts downward pressure on the price of precious metals (since they are viewed as an inflation hedge, but provide no income, they consequently become less attractive). This time is no different, with gold and silver trading back down toward their summer lows, below $1,100 per ounce for gold, according to Bloomberg data.
Given this environment, I remain cautious on precious metals. Still, having a hedge against inflation in a portfolio is a sound strategy, and I prefer Treasury Inflation Protected Securities in that role.
2. A stronger dollar supports the case for hedged currency exposure in international stocks. I continue to like international developed markets, such as Europe and Japan. However, a strong dollar can erode the local gains made in international stocks. As such, given my expectation for further dollar appreciation, I believe investors should use vehicles that hedge most or all of their international currency exposure.