Thread,
The following edited (by me) article sums up nicely some of the past discussions we have had about interest rates. Of course, the lower the rates go, the better stocks look, and the more it drives investors to invest in equities for greater rates of return.
Even though, "Asia" has me quite worried, I'm relieved that US rates have a couple of good downward whacks left to help overcome any short term problems the equities markets may face (IMHO).
Hope this helps,
MikeM(From Florida)
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How low can they go?
By Dr. Irwin Kellner
July 10, 1998- As the summer's heat intensifies, the hot topic of discussion on Wall Street is the future direction of interest rates. For, as interest rates go, so goes the stock market, prices of bonds, the dollar's foreign exchange value, and, of course, the U.S. economy. While market opinion regarding Fed policy has vacillated since the central bank last raised rates back in March 1997, the Fed has, in fact, held short-term rates steady over the past 14 months.
Next move is lower
A growing number of market participants have come to the conclusion that the Fed's next move will be to lower them. Besides the lack of inflation, there is the impact that the Asian crisis, the General Motors strike, and the need to work down excess inventories is having on overall economic activity. The economy clearly grew at a slower pace in the second quarter than it did in the first, and is set to grow even more slowly during the current period unless the GM strike is settled soon.
Low but not lowest
This is the lowest that the long bond has yielded since Washington started issuing them on a regular basis back in 1977, although far from the lowest ever for a long-maturity government bond.
Historical data on long-term interest rates.
In the 1960s, yields on long-dated governments routinely were in the 4 percent zone, while in the 1950s, they returned 3 percent or even less! These are relevant comparisons because one of the fundamentals that determine long-term rates, inflation, is as low today as it was in the 1960s and 1950s. In the past, bond buyers were satisfied with a yield some 3 percentage points over the rate of inflation. One percent inflation in the 1960s produced 4 percent bond yields then, but yields today are over a point and a half higher with the same rate of inflation.
Out of whack
This puts U.S. bonds out of whack not only with their own historical relationship with inflation, but with those in other countries as well. Our long-term rates are higher than those in most other industrialized nations, yet our inflation rates are lower.
Another fundamental is the supply of these bonds, which is a function of Washington's budget position. As you know, the government will have a surplus in its budget this year. The last time Washington had black ink for a full year was in 1969, and before that, 1960. In the 1950s budget surpluses were common.
Add in the fact that foreign investors are buying heavily because they offer better returns than these people can get in their home countries and a further decline in rates seems just about inevitable.
Inverted yield curve
If the long bond's yield breaks below 5.5 percent while the Fed continues to hold short rates steady, investors will be confronted with an unusual (but not unprecedented) phenomenon called a negatively sloping yield curve. In other words, long-term rates will fall below short-term rates (even now, yields are flat from two to 10 years). This is usually a sign that the Fed will ease, for in the past, such a development has also signaled the onset of a recession. So one way or another, look for rates to come down in the coming months.
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