How Interest Rates are Like the ‘Moving Forest’ in a Scottish Play

Actors never say the name of what they call the ‘Scottish Play’ inside a theatre. That’s because it brings down a curse on the play. Sandbags have been known to fall on actors, unoccupied cars run over people in the car park, and, according to legend, a real dagger was swapped for the retracting kind in the first ever performance. Some say the magic used in the opening scene by the three witches is real.

According to the actor Sir Donald Sinden, the truth is better than fiction. Macbeth was the default plan B of village theatre productions around England for many years. If the actual theatre production failed to draw an audience, swapping for Macb…the Scottish Play guaranteed a full house. So saying the name of the Scottish Play during a different theatre production was kind of like implying it wouldn’t be good enough and the troupe would have to use plan B.

Anyway, all this is very similar to today’s financial markets. It’s a tale of greed and delusion, and it won’t have a happy ending. The witches at the world’s central banks have brewed up a curse known as QE. Investors were sucked into the stock market hook, line and sinker, just as Macbeth was by promises of becoming king.

With the Federal Reserve’s first reduction of Quantitative Easing, we’ve reached a new act in the play. It’s the act where things get dicey. But let’s start at the beginning.

In the play, the witches tease Macbeth by saying that he can become king and his good fortune will last until the local forest comes to his castle at Dunsinane. ‘Forests don’t move’ reckons Macbeth, so he throws caution to the wind. I won’t ruin how the forest ends up moving, but I can tell you the financial market equivalent to the moving forest is moving interest rates. If interest rates begin to rise, the stock market’s good fortune will end.

Now interest rates have been in a steady downtrend since the 80s. That made debt steadily less expensive, which allowed people to borrow more and boost the economy. But, with the financial crisis, interest rates approached zero, especially once you take inflation into account. In other words, they can’t go lower.

The problem is that interest rates will rise eventually. And then all the debt incurred over the past few decades will become expensive.

So now that rates have hit zero and central banks are reducing their stimulus, the ongoing recovery is all about managing the increase in interest rates. If they rise too quickly, the recovery will stall because debt will be expensive. That would prolong the economic malaise many countries are still in. If they rise too slowly, the recovery could become inflationary. Inflation has the same effect on interest rates that screaming ‘Macbeth’ has on actors. They jump. And that leads us back to economic malaise, but with a bout of inflation mixed in.

In other words, the world’s central bankers have painted themselves into a corner. They could lose control. The lure of suppressing interest rates using QE gave them a short term gain, just as killing the king gave Macbeth his title. But now that decision could come home to roost.

So this year will be the year of watching interest rates around the world, just as Macbeth watched the forest from the top of his castle. That sounds mind-numbingly boring. But looking for cracks in a dam is probably boring too. Until it suddenly isn’t.

The most important interest rate to watch is the US 10-year Treasury bond yield. It is the rate that all others are influenced by. And it happens to be at its highest since 2011.

Did you see that tree move?

Nick Hubble +
Contributing Editor, Money Morning

Ed note: This article is an edited version of ‘A New Act in the Scottish Play’ which was originally published in The Money for Life Letter.

Nick Hubble is a feature Editor of The Daily Reckoning Australia . Nick has spent the last three years discovering lots of new, exciting and surprisingly simple ways to generate money for retirement. He’s put all these ideas into his investment publication The Money for Life Letter.

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