We have changed our interest rate call: we expect rates to remain low for the remainder of 2010 and into 2011.
Interest rates have remained stubbornly low for some time. Many of the reasons are well known:
No pressure from inflation: Core inflation in the US is close to 1.0% (and probably headed lower). The employment and capacity slack in the US economy is significant enough that companies will not be able to raise prices for a long time.
No pressure from monetary stimulus: Excess liquidity in the US banking system is sitting safely in reserve accounts and not being lent to consumers or corporations, but instead is being invested in US Treasury bonds. In fact, as a percentage of their total assets, US banks now own more US Treasuries than at any time since 1983.
No pressure from the Fed: The Federal Reserve has broadcast that it intends to keep short rates at record low levels for “an extended period” of time—and until either inflation numbers re-ignite or resource capacity starts to tighten, that “extended period” will, indeed, be into 2011.
But, as far as the capital markets are concerned, the list of unknowns has grown larger since February and created enough new uncertainty and fear that some investors have fled to bonds as a safe haven, helping to drive interest rates lower. The three largest sources of concern are 1) the deceleration in the growth rate of the US economy, 2) the possible consequences of a European sovereign debt contagion, and 3) the impact that federal government regulation and tax changes will have on business decisions, particularly as they affect employment.
Until investors gain some clarity on these three issues, interest rates will remain at historically low levels through the end of 2010 and into early 2011. But make no mistake, the structural issues that prompted our higher interest rate forecasts over the past six to nine months are still in place and waiting to reemerge—they just need consistent economic growth to draw them out.
Interest Rate Forecast: Lower Rates for Longer
We have changed our interest rate call: we expect rates to remain low for the remainder of 2010 and into 2011.
Interest rates have remained stubbornly low for some time. Many of the reasons are well known:
No pressure from inflation: Core inflation in the US is close to 1.0% (and probably headed lower). The employment and capacity slack in the US economy is significant enough that companies will not be able to raise prices for a long time.
No pressure from monetary stimulus: Excess liquidity in the US banking system is sitting safely in reserve accounts and not being lent to consumers or corporations, but instead is being invested in US Treasury bonds. In fact, as a percentage of their total assets, US banks now own more US Treasuries than at any time since 1983.
No pressure from the Fed: The Federal Reserve has broadcast that it intends to keep short rates at record low levels for “an extended period” of time—and until either inflation numbers re-ignite or resource capacity starts to tighten, that “extended period” will, indeed, be into 2011.
But, as far as the capital markets are concerned, the list of unknowns has grown larger since February and created enough new uncertainty and fear that some investors have fled to bonds as a safe haven, helping to drive interest rates lower. The three largest sources of concern are 1) the deceleration in the growth rate of the US economy, 2) the possible consequences of a European sovereign debt contagion, and 3) the impact that federal government regulation and tax changes will have on business decisions, particularly as they affect employment.
Until investors gain some clarity on these three issues, interest rates will remain at historically low levels through the end of 2010 and into early 2011. But make no mistake, the structural issues that prompted our higher interest rate forecasts over the past six to nine months are still in place and waiting to reemerge—they just need consistent economic growth to draw them out.
Mike Timm