A better question might be, ‘why does this picture appear as it does?’
The picture above is a less-than-stellar attempt to add a little class and culture to my post. The real picture I refer to is the interest rate picture. And, what appears to be wrong with that picture is rates have gone down, instead of up. Remember, the conventional wisdom in January of this year was that rates were going North as the Fed began the tapering of its $85-billion-per-month bond buying spree, Quantitative Easing (QE). For the record, the ten-year treasury yield peaked a little over 3% in December of 2013 and as of the close September 5, 2014 at 2.45% (after hitting a recent low of 2.3%).
It was always my contention even though the $85 billion per month seemed like a huge number, the fact that on average the long dated Treasury and agency MBS markets traded trillions of dollars in volume each month, QE was a drop in the bucket (Session 35b–“Fed Bolt From Hell” IIIb). When it went away it would not be missed much. At its peak QE was just a slight overbid in the market. None-the-less, I still thought (like everybody else) rates would move higher…not enough to kill the market, but enough to move us back to a more normal level vis-a-vis inflation.
Why didn’t this happen?
I had an opportunity, due to a foundation board that I sit on, to hear a presentation by Scott Colbert, Chief Economist and Director of Fixed Income, the Commerce Trust and Commerce Investment Advisors, Inc. Colbert has the distinction, two years running, of being recognized by Lipper Analytical Services as Best-in-Class Fixed Income Small Fund Group (less than $50 billion assets under management) Portfolio Manager (2013, 2012). Part of the presentation dealt with the question, ‘Why have rates gone down?’ He gave four reasons.
1. Nearly universal opinion rates had to rise–large short position
2. Very weak first quarter growth; -1% vs.+3% expectation
3. Rates overseas have fallen materially
Current 12 Month High
Germany 0.94% 2.04%
France 1.31% 2.62%
Spain 2.25% 5.09%
Italy 2.47% 4.84
Japan 0,50% 0.88%
Canada 2.04% 2.81%
Average 1.58% 3.04%
4. Low inflation CPI 2.0% PCE 1.6%. Europe0 .4%
Source: Commerce Bank and Trust Company
Again, we seemed to be the best house in a bad neighborhood
If you are Japanese, 2.45% in a U.S. Treasury looks like Nirvana compared to the paltry .88% your sovereign 10-year has averaged over the past year (.54% currently). Same holds true for Europeans. They can get around 2.5% on Spanish debt of the same maturity; but, if they want safety and a liquid market, the German 10-year is only yielding .93%, as of last Friday. Because of weak economic conditions and low inflation in the Eurozone, these low rates may continue to provide a good European bid for U.S. sovereign credits. It might even provide us some cover unwinding Q.E.
In light of all of the above, Scott Colbert still believes as we move forward ‘long, long bonds’ will NOT be a particularly rewarding strategy. And, in the near term, these low yields will continue to advantage equity investors.
One last thought on the Fed and the end of Quantitative Easing
Boston Fed President, Eric Rosengren, in an interview with Reuters said Friday (9/5/2014), “Given the “significant” slack in U.S. labor markets, the Federal Reserve should be patient about reducing monetary policy stimulus and refrain from telling markets exactly when it may raise rates.” I particularly agree with the comment about “telling markets exactly when it may raise rates.” This is TMI and probably too nuanced for the average talking head to do anything with save come to incorrect conclusions.
Did this post add any clarity on the “Why?” of lower rates in the last nine months?
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