Thursday, March 22, 2012

Explaining the recent spike in interest rates



There’s been a lot of chatter about the recent enormous “spike” in interest rates. I want to make some comments and observations.

First, this spike, while large in percentage terms over such a short period is really tiny in nominal terms. Take a look:













Once you have a little perspective the “enormous spike” becomes a joke.

Second point:

Rates are anchored by Fed policy and that doesn’t just mean short term rates, it means rates all along the curve. Whatever the Fed funds rate is will be reflected further out. A 10-year yield is nothing more than a reflection of Fed policy over that term. And since the Fed has been very clear about its intention to keep rates low and maintain a “highly accommodative” policy stance out until 2014, there is not going to be some big move up in rates. We’ve probably already hit the upside ceiling for rates.

Third point:

The rise in rates over the past several weeks has been due to a number of things, one of them being an improving forecast for the U.S. economy AND a dissipation of fears of a European meltdown. (In my opinion, the jury is still out on both of these views.)

In addition there has also been a largely unnoticed, but fairly sharp decline, in reserve balances over the past few weeks. (See chart below.) This has been due to the Fed allowing existing positions on its balance sheet to “roll off” (i.e. proceeds from maturing securities are not reinvested) AND a large amount of bond issuance by the Federal Government this month to cover expenditures, which has not been offset yet by Fed monetary operations.

On that last point, notice the recent upturn in reserve balances on the chart below. The Fed is once again stepping in to add reserves. Bottom line, the bond selloff is probably over.




7 comments:

Wekasus said...

http://ummt.org/test/ This is keeping track of comments for MikeNormanEconomics blog. ATM it is really basic, and is still being tested. So if it 'breaks' the list will not update. Comments take upto 2 minutes to show up.

Enjoy!

Anonymous said...

Should have a couple more weeks of weakness...Bill Gross hasn't gone short yet ;)

Max said...

The most important thing to realize is that higher interest rates are a good sign, along with higher stock prices. It means that people are more optimistic, which means more spending, which means more growth.

Mike Norman said...

Anon:

Right.

Mike Norman said...

Wekasus:

Thanks. Here is the link.

Matt Franko said...

Just to add to Mike's analysis here, Fed has stated that they will complete their "operation twist" type of operation by the end of June of this year.

And they have stated that their current view is to keep rates at near 0% thru 2014.

So if those things happen and the Fed does not come up with a new program to either expand/contract it's balance sheet, that should allow an 18 month period (from June 2012 thru Dec 2014) whereby the Treasury market can seek it's "natural rate of interest".

What can screw this up is a "QE3" for sure. I'm not sure of what a policy of "NGDP targeting" (which there is a lot of chatter about lately) would have on the Treasury market and if the Fed would have to get involved in the UST market because of a policy of "NGDP targeting", this is something I'm looking into lately...

Resp

Mario said...

fucking awesome analysis Mike.

And thanks Wekasus for the comments log. It's definitely better than nothing.

WTF was google thinking anyway?!?! Trying to get more people to leave their email perhaps and go the actual sites?