In the investment world, all eyes are on the Fed; most people are wondering what Thursday’s pronouncement will contain. Of course, you can read all manner of opinions as to what the Fed should (or shouldn’t) do in the financial press and on blogs.
Personally, I don’t play that game. But what is clear is that whatever they say on Thursday, they will have to follow the market at some point, and acknowledge that the trend in US interest rates is firmly up.
Here is a chart of the effective Fed Funds rate over the decades, showing how today’s virtually-zero rate is unprecedented:
Remember, the effective Fed Funds rate is the rate on overnight balance transfers between banks of their accounts with the Federal Reserve.
And since the introduction of the Fed’s zero interest rate policy (Zirp) in 2008, the Fed funds rate has been pinned to the floor in a deliberate attempt to ‘stimulate’ the economy.
But lately, this rate has been inching upwards. Currently, the effective federal funds rate is at 0.14%, compared to 0.09% last year. Needless to say, this is a lot lower than the long-term average of 5.02%.
Here is the chart from February to July, showing the gradual rise:
From the February rate of 0.110%, the market rate has risen by 18% in five months. I believe this is significant.
Also, note the crossing of the 200-day moving average (thin red line), which is usually taken as a change in trend.
Many are calling for a ‘normalisation’ of rates – does that mean a rise to the long-term average of 5%? If that occurs, there will be mayhem in all markets.
US interest rates – the long-term picture
So, short-term rates are rising, what about the long-term rates? Here is the US Treasury 30-year bond chart:
The 30-year Treasury yield bottomed out last year in the 2.25% area and today, it is at 2.94% – a rise of 30%. This is a little surprising because inflationary pressures have been very weak with plunging commodities and wage/salary restraint almost everywhere.
The 30-year rate is determined partly by inflation expectations – and these have been very moderate, not to say deflationary. If anything, the component from inflation should be much weaker than in normal times.
So what can explain the rising trend in yield? It cannot be the growing fear in financial asset markets, such as in stocks. When stocks are shunned, as occurred last month, there is usually a flight to the safety of Treasuries, driving yields lower.
Could it be the result of large-scale selling by China and/or other emerging markets as they must raise dollars to finance their operations and keep their bond dividend payments current? After all, the vast majority of international debt is denominated in US dollars.
Incidentally, this growing international (and US-based corporates) scramble for dollars to service debt will confound the pundits who forecast a dollar collapse. I have long maintained that the dollar will surge to reach the 120 value from the current 95 print.
In any case, it is clear that there is only one way for rates to go – it is up off the floor. The only question is when.
We may get a clue on Thursday.