I have been saying this for quite a while but, when we talk about "interest rates" going up, we need to differentiate across the yield curve between the overnight rate all the way out to the 30yr rate. This is called the "yield curve".
Well, by now, most expectations are building that the Fed will raise rates at their June or July meeting. Now remember, they are only raising the overnight rate. Our view is that they may indeed go once or even twice by the end of the year but that it is these overnight (Fed Funds) rate hikes that have a pretty good chance of starting a recession, at least if history repeats.
So, as the Fed starts raising rates, which they began in December 2015, the yield curve starts to flatten. We show this through the differential between the 10yr rate and the 2yr rate (the lower the orange line, the flatter the yield curve which is on the LHS). The white line (RHS) is the Fed Funds rate (upper band).
In fact, not only does the yield curve flatten, it actually has the potential to go inverted! Look at how inverted/negative it got during the 80's, 90's and early 00 (I always thought those were the best of times...Disco, Ronald Reagan, The Brunswick House...those were the days).
So why does this happen? Well the enemy of bonds is "inflation" and the friend of bonds is "disinflation/deflation". So the longer part of the yield curve (10yr and 30yr) is telling us two things: 1) There is likely no inflation building and, in fact, there may very well be some disinflation/deflation (notice that central bankers in every other country in the world are trying like crazy to create inflation...Japan has been trying for 25yrs!) and 2) That the Fed may very well be making a policy error. A policy error would mean that the bond market does not believe that the US economy is as strong as the Fed tells us it is (they have been wrong for 8yrs) and they too, like other central bankers, are scared spit less about deflation. Should the Fed embark on a more aggressive rate hike path, they would be doing so during a corporate profits recession (we have seen 4, coming on 5, sequential quarters of negative corporate profit growth). Chalk it up to bad timing.
So the bottom line is, the bond market is doing exactly what it should doing...IE...Flattening. That is part of the reason why we hold a good-sized position in 30yr Gov't bonds (it also acts as a natural/passive hedge to a portfolio with a Flight to Quality/Safety if we are right and a recession develops...should that happen with stocks near their all-time highs, folks will squeeze out of stocks and ramp into Gov't bonds, especially out the yield curve. So we are quite long 10yr and 30yr Gov't bonds and long very little inside of that part of the yield curve.