LearnBonds.com

When Will Short Term Interest Rates Rise?

US Interest Rates
Rate this post

The basic headlines indicate that there is great concern within the Federal Reserve about when short term interest rates are going to rise and how they will rise.  In addition, we read in recent days about how officials within the Fed are working on the wording relating to “forward guidance” about when short-term interest rates are gong to rise.

Yet, if you look at the bond markets, the yields on longer-term securities continue to fall.

Six months ago in the United States, the yield on the 10-year United States Treasury note closed at 2.64 percent.  Two weeks ago…just before Thanksgiving…the yield had dropped to 2.36 percent…a decline of 28 basis points.

To see a list of high yielding CDs go here.

And, on Tuesday, the yield on the 10-year dropped to 2.22 percent, another 14 basis point drop from two weeks ago.

This, however, seems to be a global phenomenon.

In Europe, the yield on the 10-year German bund closed at 0.69 percent on Tuesday.  This was down 15 basis points from the yield two weeks ago…and down 72 basis points from the 1.41 percent yield of six months ago.

But, this drop in yields was taking place throughout Europe.

The yield on the 10-year French government bond dropped from 1.76 percent six months ago, to 1.18 percent two weeks ago, to 0.97 percent on Tuesday.  The six-month decline was 79 basis points.

The yield on Spain’s 10-year bond dropped from 2.64 percent six months ago to 2.11 percent two weeks ago.  And, on Tuesday the yield was 1.84 percent, down 80 basis points from June 10.

In Italy, the declines were similar.  The Italian bond closed to yield 2.04 percent on Tuesday, 76 basis points below the 2.80 yield that existed on June 10.  Two weeks ago the Italian 10-year stood to yield 2.33 percent.

The only thing that can be pointed to at this date is the gloom and doom that investors seem to be projecting on the European economy…and on the United States economy.

Forecasts of economic growth in 2015 seem to be fairly optimistic.  People are looking at labor market statistics, for example, and saying that it looks as if the economy is improving.  But, analysts have been seeing “green shoots” in the economy for the five years of the current economic recovery.

Yet, for the five years ending June 30, 2014, the compound rate of growth of the United States economy was only 2.2 percent.  The year-over-year rate of growth for third quarter GDP was just slightly higher at 2.3 percent, even though the annualized quarter-to-quarter rate of increase was substantially higher.  Officials at the Federal Reserve are only projecting growth over the next two to three years in the 2.0 percent to 2.5 percent range.

Inflation has been coming in below the Fed’s desired rate of increase of 2.0 percent.

And, if one looks at the inflationary expectations investors have built into government yields, one sees a substantial decline in the market’s forecast.  Six months ago, investors had built in 10-year inflationary expectations of 2.25 percent.  Two weeks ago, these expectations had dropped to 1.96 percent.  On Tuesday, investors had reduced inflationary expectations to only 1.76 percent.

Over the last six months, investors in the bond market seem to have completely changed their view on the strength of the United States economy over the next five years…over the next ten years.

Rather than becoming more optimistic about future economic growth and future inflation, bond investors have become much more pessimistic.

And, Europe?

The gloom seems even more pronounced.  Can you imagine a relatively healthy Germany, the largest economy in the eurozone, having a yield on its 10-year government bonds at 69 basis points?

But, more and more analysts are concerned that deflation is going to be coming to Europe in the near future.  The most pessimistic seem to believe that Europe will be going through a period similar to what Japan went through over the last ten years: little or no economic growth with deflating prices.

Can you believe that such “sick” economies like France, the second largest economy in the eurozone, has a yield 125 basis points below that of the United States.  And, Italy, the third largest economy in the eurozone, seeing a yield 18 basis points below that of the United States.  And, Spain, showing a yield almost 40 basis points below that of the United States.

These are not signs of strength in the bond markets…but, signs of the severe economic problems being faced in these countries.

And, last week, the European Central Bank just released revisions of its growth projections for the eurozone.  Everything forecast was reduced for the next three years indicating that the ECB can find little in the economies of Europe to be cheerful about.

Going into 2015, this is the environment bond investors are facing.  I have not yet put together my forecast interest rates for the next year or so, but the data reported in this post are just some of the things I am looking at.

Views expressed are those of the writers only. Past performance is no guarantee of future results. Trading comes with severe risk. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
Avatar

John Mason

Write first comment

Reply

Your email address is not published.