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July 2, 2007

Interest Rates in the News Again

It wasn’t too long ago that writing an economic analysis column meant – surprise – that you analyzed the ups and downs of the economy.  And if you came of age in the 60’s and 70’s, there were plenty of ups and downs to keep track of.  Volatility in just about everything was higher then, with strikes, inflation, and more frequent recessions the order of the day.  And even though that environment has changed remarkably since the mid-1980’s, the habit of peering at the data for the first whiff of trouble is a hard one to shake.

But the experience of the last twenty year’s longer expansions and less frequent recessions has gotten us into some bad habits.  Since the economy always seems to keep growing – whether we write about it or not – we’ve started analyzing other things.  Health care, convention centers, sports stadiums, even daylight savings time.  It’s been fun, and hopefully it’s even been relevant. 

But the economy remains the big story, whether it’s mentioned or not.  It may be resilient, but it is not invulnerable.  And however much we might enjoy, and even take for granted, the remarkable stability in prices and growth we’ve experienced since the days of Paul Volker’s reign at the Federal Reserve, there is nothing written in stone that says things will continue this way for the foreseeable future.

Indeed, things may be changing already.  After lying dormant for nearly five years, interest rates have risen significantly in the last 30 days.  At some point in mid-May, the so-called inverted yield curve – that relatively rare occurrence where long-term yields are actually lower than the yield on much shorter term investments – flipped back around, with yields on 10-year Treasury bonds climbing to levels not seen since 2002.

Why that is happening is not exactly a mystery to economists.  Although individual forecasts vary, for each of the last three years we’ve been saying long term rates will rise above five percent.  But it hasn’t happened – until now.

If it were up to the American public to supply the funds to credit markets, rates would have risen sky-high a long time ago.  On a current-income basis, American households still have negative aggregate savings rates, and sizable federal government budget deficits add more to the imbalance.   Fortunately for all of us, foreigners and foreign governments have proved more than willing to pour money into our credit markets, even as the declines in the dollar chip away at their returns in doing so.

So the reasons for the half percentage point rise in long term bond rates in the last month are largely found offshore as well.  Either there has been a sharp upward revision in expectations for inflation in the future, or there are simply less funds to invest coming from abroad.  And if the latter is the case, we could find long-term rates oscillating about higher levels – north of 5 percent – for some time to come.

Those would not be happy circumstances for the housing market, already beset with difficulties as it unwinds from its super-heated peaks of two years ago.  Higher rates will push more over-leveraged speculators towards insolvency and dry up the already withering flow of funds from mortgage refinancing available to finance consumption.  It all adds up to another sting in the midst of a correction that is already causing considerable pain.  And it increases the chances for government intervention in the credit marketplace that will almost certainly prove worse than the disease.

From a historical perspective, yields in the neighborhood of 5.5 percent on 10-year bonds can’t really be called “high.”  And an upward movement in interest rates in an economic expansion is hardly an unexpected event.

But the massive flow of funds from abroad coming into the U.S. has lulled us all into believing that we could enjoy lower interest rates forever.  And waking up from that dream is not pleasant.

Link to this commentary: https://commentaries.cberdata.org/160/interest-rates-in-the-news-again

Tags: economics, finance


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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