Investing in 2015 the Knowns and the UnknownsAuthor: John MasonLast Updated: January 8, 2015 A lot of things are hitting the bond market these days. Most of the “new” things are related to the uncertainties of the new year, things that I would call “known unknowns.”It is not that the events hitting the bond market were not foreseen. Hence, I don’t think that we can call them “unknown unknowns”.For example, the fact that the United States dollar was rising in value and was expected to continue to rise in value against most major currencies in 2015 was not unknown.The fact that the price of oil was declining and would, possibly, continue to decline in the new year was not an unknown.The fact that a lot of other countries in the world were having economic problems, which would continue into 2015, was not an unknown.The fact that a lot of these factors hit the new year with such force…has been a surprise.Now we have to respond to what is going on.Many, including myself, had projected a further rise in the value of the US dollar this year, but it was not expected to take place quite so soon. Perhaps the earliest that it was expected that the dollar value of the Euro would drop was after the January 22 meeting of the European Central Bank.However, on Monday, January 5, the dollar value of the Euro dropped below $1.20. On Tuesday, January 6, the dollar value of the Euro closed below $1.19. Talk is increasing that we may see this rate drop to around $1.10 sometime in 2015.The price of oil fell below $50 a barrel on Monday, January 5 and then fell below $48 a barrel on Tuesday.Furthermore, economic turmoil continued to grow in Europe as information that price inflation continued to decline in Germany and outright price deflation took place in Spain. In Germany, the consumer price index fell to 0.1 percent in December 2014 while in Spain, the year-over-year price decline from December 2013 was 1.1 percent. It is expected that the price index for the whole eurozone, which will be released this week, will show a 0.1 percent rate of decline for 2014.In addition to this, political turmoil is adding to the economic problems of the eurozone. Elections are being held in Greece for a new leadership of the country. Expectations are that a populist party and its leader will become the new government of Greece. These people have entered the election in favor of Greece leaving the monetary union, something that no one who joins is supposed to do.Obviously, this raises the uncertainty connected with the Euro and with the European Union.The rumor around the financial markets these past two days is that risk averse funds are beginning to leave the eurozone again and are finding their way into “safe havens” around the world.As a consequence, some interest rates are falling. For example, the yield on the 10-year German bund closed at 0.45 percent on Tuesday, a new historical low for the German debt. A week and a half ago, the yield was around 0.60 percent or above. The debt of the German government is also considered to be a “safe haven.”In the United States, money seems to be flowing into Treasury securities again. For example, the yield on the 10-year US Treasury note closed on Tuesday to yield 1.94 percent. This is down over 25 basis points from what the yield was a week and a half ago.Two other things to note: first the yield curve of US Treasury issues has flattened considerably over the past two weeks. The spread between the yield on the 10-year note and the 2-year note dropped about 20 basis points over the last two weeks from slightly more than 150 basis points on Christmas eve to just over 130 basis points on Tuesday. The compression of the yield curve is quite impressive for such a short period of time.Furthermore, the yield on the 10-year US Treasury Inflation Protected Security (TIPS) dropped 17 basis points since December 24. On December 24, the yield was 0.58 percent and Tuesday, the security closed to yield 0.41 basis points.The TIPS yield is an interesting thing to watch. As the debt crisis in Europe began to pick up speed in the spring of 2011 and risk averse money began flowing from Europe to the “safe haven” of the United States, the yield on TIPS fell dramatically and turned negative in the summer of that year. In the summer of 2013 the yield was still in negative territory, but as the debt crisis eased in Europe eased as the fall of 2013 progressed, the TIPS yield became positive once again and rose, even reaching close to 1.00 percent.If risk averse money has begun to flow into the United States once again one might expect that the yield on TIPS will again dip. How far yields on these securities fall is anyone’s guess.In summary, the US bond market has gotten hit early in the year 2015 by events that have caused the yields on United States Treasury securities to fall. The lower inflation figures, the falling price of oil, the financial problems in Europe…and much of the rest of the world…have all played their part in the decline in longer-term Treasury rates.It seems as if investors keep expecting longer-term US interest rates to rise…and, instead, they keep falling.In addition, this is making things tougher on the Federal Reserve. The Federal Reserve has indicated that it would like to raise interest rates later this year. However, the Fed has injected so many reserves into banking system that it currently needs to work off some of this excess supply so that it can, later this year, be able to actually cause interest rates to rise.With all of the funds flowing into the US security markets, the Federal Reserve has, in fact, seen its policy rate, the federal funds rate, fall during the past week due to the increased liquidity of the American money markets.If longer-term interest rates are falling as well, officials at the Federal Reserve will have a difficult time in raising its target rate of interest. What a dilemma!In summary, let me just say that a lot of things are going on in the bond markets in the United States…and around the world. This is a time for investors to be loose and nimble in their thinking because many, many things are…and will be…impacting the financial markets and interest rates during the year.Some of the factors impacting the financial will be “known unknowns” and some will be “unknown unknowns.” The uncertainty connected with these “unknowns” will impact the volatility of the markets. We have already seen a rise in the volatility measures used to judge the volatility of the stock markets. This volatility, in my mind, will impact all financial markets in 2015.This is the reason to be loose and nimble…and observant…with regard to what is happening. Best wishes and Happy New Year!About John Mason John has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.