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What will drive interest rates up?
In investing, it's important to think unconventionally and creatively while at the same time considering risks - no matter how remote or unmanageable they are. I keep thinking: What would drive our interest rates up in the US?
China is the obvious culprit as it's the largest holder of our fine Treasury obligations. If China's exports to the US don't recover to the pre-Great Recession level then, considering its large overcapacity and bad-debt problems, it may quite suddenly find itself unable to buy as many of our bonds/bills. Or even worse, it may start selling them. But this scenario is one I've discussed in the past more than once.
Then you start looking down the list of who's who in the ownership of our government debt, and you find Japan only slightly behind China. Japanese interest rates were circling around zero, but they still failed to stimulate the economy that's been in a recession for as long as I can remember. The Japanese savings rate was very high, and thus, as government debt ballooned over the last two decades, it was happily absorbed by consumers who were net savers – they had extra funds to invest. However, Japan has one of the oldest populations in the developed world. As people get older they save less; thus the savings rate has been on a decline in Japan. (The fact that their exports fell 36% did not help their savings rate, either. To save you need income).
The appetite for Japanese bonds will decline in tandem with their savings rate. The Japanese government (and corporations) will have to start offering higher yields to entice interest in its bonds. Interest rates in Japan will rise, and this of course will put a significant interest-servicing burden on the already highly leveraged Japanese government. But more importantly (at least from our selfish US perch), Japan will finally become a formidable competitor for borrowing. Our borrowing costs will rise. In addition, Japan may also start buying less or selling US debt, not by choice but out of necessity, putting additional pressure on US interest rates.
Not to appear as an “on the other hand” economist (I'm not one), but the counterargument to this is, the US consumer may become a net saver and will be able to offset (at least some of the) declining demand from our friends across the Pacific.
P.S. I was interviewed in last week's Barron's (you can read full interview on SmartMoney).
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007). To receive Vitaliy's future articles my email, click here.
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The question should be WHY not WHAT. Debt monetization is a one way street in the current landscape. Consider these points: 1) The member banks will kill you if you reverse the course. 2)IMF would be more than happy to fill the void left by the FED. 3) Where exactly is the demand for commercial loans to come from, so that the banks could raise the rates? 4) Plenty of Viagra (stimulus) money is available.
It's going to be Oil.
Someone attacks Iran after Monday 10 Am (EST, Israel sunset 5:30 Pm) Completion of Yom Kipper. Or Iran attacks somebody.
Oil takes off to at least 100 Barrel, maybe 500 Max if Tankers and Oil Facilities or Rigs are lost.
Interest rates will start marching when the money flows into Wall Street to buy Oil below 100 when the shooting starts. There is probably enough speculators with sufficient money, credit etc to make it happen.
er...perhaps but I'd call a 50/50 that US treasuries benefit from flight to quality/safety in that arrangement.
1st run is always to treasuries
2nd run is always to gold
very relevant & important topic.
I've read a lot lately about the US Fed printing/devaluing the dollar to monetize the debt, save failed businesses, improve its international competitiveness & reduce unemployment. if it were only that simple!
i doubt that devaluing China's $2T in US reserves is going to happen without their consent & if it does, say hello to a mega international trade war, skyrocketing commodities including gold & oil, and real wars waged to seize control of them.
and simple printing isn't going to save the US economy and suddenly create millions of new manufacturing jobs - not when the economy is based on a consumer (who likely works in the FIRE service sector) with an acquired taste for cheaper/higher quality imported goods over more expensive/lower quality domestically produced ones. inflation or possibly hyperinflation, with much of the resulting damage inflicted on the growing poor & shrinking middle class, all while alienating your biggest trading partners, doesn't seem like a viable option.
what is left is raising rates to encourage domestic saving, which will also create greater short term pain & dislocation in the economy by sinking failed businesses currently on the brink, but will also keep creditors happy which is important since you're going to need them to support growing government deficits & debt used to hopefully invest in real sustainable job creating programs & infrastructure (eg. energy self-sufficiency, overhauled health care/biotech, etc.)
I expect interest rates to shoot up only if/when the Fed decides to stop monetizing the debt. This will have a devastating effect on the economy. What do you think will happen to home prices, light vehicle sales, and equity markets when interest rates start shooting up?
It could start this month.
Correct. Assuming "muddling through" as a more probable course than "apocalypse", neither China nor Japan will dump their Treasuries. Of course, they may (or may not) slow purchases or stop buying them at all. Much ink has been spilled for years on predictions about this, all wrong so far. But the biggest player - in terms of current purchases, which is what is determining current rates - is the Fed. They are buying approximately half the issues.
I don't know when it will happen, or even if it will happen (it's always possible we've entered a "new paradigm"), but should the Fed EVER stop those purchases then bond prices will go down and rates will go up. Consequently there is more world-wide attention on the Fed's QE actions than on all the other global financial events added together. Also consequently, BB makes very public statements that - even though he claims the recession is over - QE and low Fed Funds rates will continue "for the foreseeable future" (as in perhaps "forever").
Nice interview...as for this bond commentary, quite frankly it blows. China + Japan own a lot of US Treasuries, and they might want to sell ! US consumption might be curtailed due to the personal savings rate improving ! Pardon the mockery, but come on.
Here's some random thoughts on driving US interest rates higher:
- US politicians find new reasons to pass "son of stimulus" as Joe Biden is full of it. Not enough jobs being added, so let's create fake, feel-better jobs. Budget deficit worsens
- Brian wesbury is right and the US grows by 3-4% GDP over the next few quarters. I question this scenario's occurrence under the "V recovery"
- US health reform passes and proceeds to blow new layers into the federal debt. Those 'cost savings' are just a mirage