Eyes wide shut?
Eyes wide shut?
Commentary: Interest rates are already falling again
By
Dr. Irwin Kellner, MarketWatch
Last Update: 12:01 AM ET Aug 1, 2006
HEMPSTEAD, N.Y. (MarketWatch) -- Are the bond market vigilantes sleeping or do they know something that the rest of us don't?
While long-term rates have bounced higher since reaching multi-decade lows back in 2003, they are still well below rates seen during the earlier years of this decade -- not to mention during the 1990s and 1980s. On Monday, the benchmark 10-year note closed with a yield of 4.986%, down from 5.138% a month earlier.
See related story.
Yields are even lower, when you consider the rate of inflation. Except for a couple of brief periods in 2005, "real," or inflation-adjusted yields haven't been as low as they are today in at least a quarter of a century.
How low are real rates today? Would you believe 0.7%? That's right, fans, less than one percentage point. It's a far cry from the 3% real rate of return that the literature says investors in Treasury notes should get to compensate them for doing without their funds over such a long period of time.
How do we come up with such a low real interest rate? There are any number of price indexes you can use and periods of time in which to measure their rate of change, but to simplify matters I used the most recent 12-month change in the consumer price index. As of June, the CPI was 4.3% above its year-ago levels, so subtracting this from the current 10-year note's 5% yield produces 0.7%.
If you think that the last 12 months were an aberration and would prefer 24 months, instead, the inflation rate averages 3.4%. Subtract that from 5% and you get 1.6% -- about half the real rate of return investors should be looking for.
Since inflation, if anything, is accelerating, and Washington's burgeoning budget deficit is boosting the supply of Treasuries, you would think that buyers of this bellwether would be demanding a higher yield. You would be wrong.
Investors, it seems, can't get enough of these securities, especially if they reside abroad. Latest figures show that net capital flows into the U.S. rose to $69.6 billion in May from $51.1 billion in April.
See related story.
Some of this may reflect the fact that interest rates are higher here than they are in most other countries. Some no doubt also traces to a flight to quality as investors shift money into safe Treasuries during times of uncertainty.
See my column of July 18.
But a whole lot appears to be due to a growing feeling that economic growth is fading so fast that the Federal Reserve will have no choice but to end its 25-month regimen of raising short-term interest rates as soon as next week.
Now those of you who look at our forecast page know that not everyone thinks this way, myself included. You will also note from this page that there are the always-volatile labor force statistics that will be released between now and August 8th, when the Fed's rate-setting Open Market Committee holds its next confab.
See Economic Forecast page.
Even if July turned out to be another weak month of job growth, the current inflation stats plus new Fed chief Ben Bernanke's need to prove his mettle as an inflation fighter suggests at least one more hike, to 5.50%. And if the labor data surprise on the upside, as they have been known to do, the bond market vigilantes may open their eyes to inflation and adjust rates accordingly.
Dr. Irwin Kellner is chief economist for MarketWatch. He also is the Weller professor of economics at Hofstra University and chief economist for North Fork Bank.