NEW YORK (Real Money Pro) -- Most people call their musings on 2015 a "forecast" piece, but in my old age I've begun to eschew that word. This Web site is called Real Money Pro for a reason, and I don't manage money via forecasts or predictions. Why write a bunch of predictions that even I don't trust enough to trade? Rather, I think in terms of probabilities and possibilities.
I ask myself a series of "what if" questions, reason out how such a scenario might develop, and then think about what trades could work across multiple scenarios, or at least work great in the more likely scenarios and not too badly in the other scenarios.
I will break this into two parts, with today's column on interest rates and Friday's on credit.
What if interest rates rise substantially?
The most likely reason why this would happen is the economy accelerates in the first and second quarters, which either pulls Federal Reserve rate hikes forward into the spring and/or causes the Fed to raise rates more aggressively come the summer. The former would cause considerable volatility, but, ultimately, the latter is more impactful, and thus where I'm focusing my time.
The key factor is employment. If job gains continue at the current pace, unemployment will hit 5.0% by June, and the Fed will have hiked at least once by then.
What if interest rates fall?
It is hard to imagine short-term (0 to three-year) interest rates falling. That would require the Fed hiking only once or twice and it subsequently becoming clear that it isn't going to hike again for a year or more. That would cause two-year Treasuries to drop into the 0.50% area, from the 0.68% area now.
It's not quite as hard to imagine, but still highly unlikely, that five-seven year bond yields fall. In order for that to happen, the pace of Fed hikes would have to be seen as extremely slow, like 0.25% worth of hikes every four months or so. It would also require an assumed early stopping point, certainly no higher than 1.75%. So, basically we're talking a scenario where the Fed hikes six to seven times over a 2 ½ year period.