I have written several posts recently about how cash flows throughout the world have impacted the United States bond markets and influenced the level of interest rates in America. The cash flows I have been talking about in the past have been those funds that have left European financial markets and flown to the United States…and then returned to Europe.
The flows have generally been connected with how investors have felt about risk. Three years ago, investors in Europe became very concerned about the sovereign debt of many European countries. Many of these investors sold their European sovereign debt and brought their money to the United States seeking a “safe haven” for their funds. This resulted in a substantial drop in United States interest rates. For example, the yield on U. S. Treasury Inflation-Protected securities (TIPS) even became negative during this time period.
As things the economic environment stabilized in Europe, investors began bringing funds back to the continent from the United States. As a consequence, interest rates in the United States rose.
Last week a situation arose concerning some nations that are included in the list of so-called Emerging Markets (EM) countries. These nations have weak economies and their governments are facing fiscal difficulties. On Thursday, the currencies of these countries came under selling pressure and the value of these currencies fell rather dramatically.
More specifically, the nations who felt the greatest amount of this selling pressure were Argentina, Turkey, South Africa, and Brazil. These are countries that many analysts believe need “some deep economic adjustments.”
The governments of Turkey and South Africa raised short-term interest rates to fight the declines in the value of their currencies.
The EM continued to experience selling pressure through Wednesday, January 29.
How EM Volatility Could Help US Finanical Markets
This, like the earlier situation in Europe, could help financial markets in the United States. In fact, there is already some evidence that this could cause another movement of funds, internationally, which could soften interest rates in America.
Last Wednesday, the yield on the 10-year TIPS closed at 0.580 percent. On Thursday the rate dropped to 0.515 percent, reflecting a pretty substantial decline. The rate was trading around 4.20 percent, yesterday, January 29.
The yield on the regular 10-year Treasury note dropped in parallel with the fall in the TIPS rate. Last Wednesday the spread between the 10-year TIPS and the 10-year note was about 228 basis points. Yesterday the spread between these two issues was around 227 basis points.
One further point should be made here. Beginning in January, the Federal Reserve began to “taper” its purchases of securities. During 2013, the Federal Reserve had been purchasing $85 billion in U. S. Government securities and mortgage-backed securities every month.
At the December meeting of the Fed’s Open Market Committee, the decision was made to reduce the amount of securities that the Federal Reserve purchased every month should be dropped to $75 billion. This “tapering” of purchases was expected to put pressure on United States interest rates to rise.
At the meeting of the Open Market Committee on Wednesday, January 29, the Federal Reserve voted to reduce the amount of securities it purchased every month to $65 billion. This move was expected.
In spite of the news of this planned reduction in Fed purchases of bonds, the yield on the 10-year U. S. Treasury note fell. Obviously, something else was at work in the marketplace.
Investors in the bond market need to take into consideration these international flows of funds for they are going to affect the volatility in the bond market. In fact, all the volatility measures connected with financial markets in the United States bounced upwards toward the end of last week.
Interest rates are still expected to go up in the United States this year. But, as we saw two and three years ago, international flows of funds can have major impacts on just where interest rates end up. They are just another factor that good investors take into account when managing their portfolios.
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.