Where could interest rate go in the short and long term?

13 posts / 0 new
Last post
Ruhh's picture
Ruhh
Status: Gold Member (Offline)
Joined: Nov 12 2008
Posts: 259
Where could interest rate go in the short and long term?

Interest rates are currently at historic lows. How long will they stay there? What will trigger them to go up or further down?

From what I understand and think I've leaned is that hyperinflation could possibly send them back up. If that did happen, how high can they go? And what could happen to revolving credit (aka credit lines)

Thanks in advance for any insight.

r.

affert's picture
affert
Status: Silver Member (Offline)
Joined: Sep 22 2008
Posts: 100
Re: Where could interest rate go in the short and long term?

I have no idea how this will effect other interest rates, but if China ever stops buying treasury bonds, the long-term bond interest rates will go up, and probably quite a bit. 

As I understand it, the federal gov't does auctions to sell the bonds.  The more people that want the bonds, the lower the interest rate they are willing to take.  The gov't is clearing going to need to borrow a lot of money, at least in the near term future, and if they want to borrow more money than people want to lend, rates will go up.  

Could someone talk about what is likely to happen to other interest rates in the event of bond rates jumping?  Will this cause other interest rates to also go up?

Amanda V's picture
Amanda V
Status: Gold Member (Offline)
Joined: Dec 31 2008
Posts: 262
Re: Where could interest rate go in the short and long term?

Ha ha !  You've got me answering first - and I am dumb at economics.  But I want to give it a whirl as I love TRYING to get my head around it.  Just remember there are lots of other threads that have come up with this discussion and others have offered some really good explanations.  So do read through those as well.

My limited understanding is:

Interest rates are driven primarily by two factors, inflation and GDP. 

Inflation is strongly weighted to the housing market, with commodities contributing I think about 40% of the calculation.  High inflation would encourage interest rates to go up.  But housing would have to start picking up for that to happen.

GDP is a measure of growth and if the growth is zero or below that for two quarters, the economy is officially in recession.  So then the government puts interest rates down to try to stimulate growth.

Interest rates can't go down any further in America, so that is out. 

At the moment there is deflation due to the recession.  My belief is that if there is hyperinflation due to the continual printing of money, it will put commodity prices up not real estate.  So the technical inflation figure will look better than it feels to most Americans.  Americans are struggling and they are likely to want to buy food and essential commodities before houses.  

America economy/dollar/banks could collapse before it gets to hyperinflation.  I recommend all readers subscribe to Chris' subscription newsletter.  It helps the cause and gives warnings as to what is happening. 

I don't know what could happen to revolving credit.  If the bank shuts down you don't get it I suppose. 

I am really keen to be shot down in flames if appropriate - and given a lesson on all this by someone who is more in the know.  Make it "interest rates for dummies" though.  Be very simple.  It is hard to grasp for some of us.

 

Farmer Brown's picture
Farmer Brown
Status: Martenson Brigade Member (Offline)
Joined: Nov 23 2008
Posts: 1503
Re: Where could interest rate go in the short and long term?

Yes, other rates will go up, which is exactly why the government is, shall we say, in a noodle:

Stimulating the economy, in their world, means keeping rates super low.  But, they also have to borrown tons of money.  Even without the stimulus, but moreso with it, they would have to borrow tons of money.  This is because tax revenues will be down severaly, and because governments generally run deficits even in good times.  That's just what they do. 

When the bond rates go up, the "keeping the rates low" part of their plan goes up in smoke.  You're left with hyperinflation and a stagnant economy, i.e., stagflation.  

Don't say that word in the halls of the fed or in some parts of congress, or it will make hair curl and pacemakers stop, so be vewy vewy kafule.

Amanda V's picture
Amanda V
Status: Gold Member (Offline)
Joined: Dec 31 2008
Posts: 262
Re: Where could interest rate go in the short and long term?
affert wrote:

I have no idea how this will effect other interest rates, but if China ever stops buying treasury bonds, the long-term bond interest rates will go up, and probably quite a bit. 

As I understand it, the federal gov't does auctions to sell the bonds.  The more people that want the bonds, the lower the interest rate they are willing to take.  The gov't is clearing going to need to borrow a lot of money, at least in the near term future, and if they want to borrow more money than people want to lend, rates will go up.  

Could someone talk about what is likely to happen to other interest rates in the event of bond rates jumping?  Will this cause other interest rates to also go up?

 

I'm already lost.

Farmer Brown's picture
Farmer Brown
Status: Martenson Brigade Member (Offline)
Joined: Nov 23 2008
Posts: 1503
Re: Where could interest rate go in the short and long term?

Amanda,

The question was, what will happen to overall lending rates if US Treasury bond rates go up.  

The answer lies in understanding the relationship between T-Bills and lending rates, which is as follows:

When you deposit your money in the bank, they have to decide how to invest it in order to pay for the services they provide us in exchange for the privilege of handling our money. US-T Bills are the biggest market of them all, and the safest, so whatever the government is paying is the standard by which all other loans are measured.  That means that they are not going to lend anyone else that money unless the return is bigger or safer.  That is, all other loan rates automatically get pegged higher as a result.

Hope that helps.

 

Farmer Brown's picture
Farmer Brown
Status: Martenson Brigade Member (Offline)
Joined: Nov 23 2008
Posts: 1503
Re: Where could interest rate go in the short and long term?

PS:  The other piece of the puzzle is the Fed Rate.  This is that rate at which the Fed lends momber banks money.  If the Fed rate is low, as it is now (it's efectively 0.25%), then you, as a bank, would find it entirely profitable to borrow from the Fed at 0.25%, and use that money to buy government bonds that are only paying 2% or 3%.  May sound small, but hey, it's free money. 

The Fed is probably not going to raise rates anytime soon, but bond rates may go up (and have recently started to) anyway.  This could be attributable to private investors diversfying away from dollar-backed investments, our of fear that the dollar itself is in trouble.  

Whaveter the reason for bonds going up - whether because of the base Fed rate, or because of how the bonds are traded in the free markets, it will always follow that lending rates, at least in the US or wherever dollars are the currency, will rise because of what I hope I was able to explain in the first post. 

 

Ruhh's picture
Ruhh
Status: Gold Member (Offline)
Joined: Nov 12 2008
Posts: 259
Re: Where could interest rate go in the short and long term?

Thanks all.

Up here in Canada interest rates are down and our government is also starting to go back into debt but not quite at the same rate as our southern neighbours. If the USD does start to collapse I imagine the CAD would do the same but that there would be some lag.

Here's where we're at to help you understand our concerns. We found a perfect cottage/farm property that we're planning to transform into our off the grid permaculture heaven. So many of the peices are already in place for it. However, because it's so cheap and isn't connected to utilities we can't get a mortgage but can get a credit line at pretty much the same interest rate. We'll pay it off very easily in less than 5 years and our jobs are secure but the interest rate is not locked on that revolving credit. I just don't want to get too deep but we need to secure the property as there isn't anything like it. I think we're safe to go ahead and buy it. Worse comes to worst we can always live there and commute since it's close enough to commute and put our rent toward the credit and be out in no time. We currently have no other debts at the time being either.

Any other perspectives on how Canada will deal with worst case scenarios in the US?

eternal sunshine's picture
eternal sunshine
Status: Bronze Member (Offline)
Joined: Sep 24 2008
Posts: 50
Re: Where could interest rate go in the short and long term?

I don't have any myself but maybe some historical links between inflation and interest rates would be useful here in various economies?

Also the 10 yr T-bill has yield has been dropping all this week - does anyone think this is an indication that the fed has started purcasing treasuries directly?

 

affert's picture
affert
Status: Silver Member (Offline)
Joined: Sep 22 2008
Posts: 100
Re: Where could interest rate go in the short and long term?
Amanda V wrote:
affert wrote:

I have no idea how this will effect other interest rates, but if China ever stops buying treasury bonds, the long-term bond interest rates will go up, and probably quite a bit. 

As I understand it, the federal gov't does auctions to sell the bonds.  The more people that want the bonds, the lower the interest rate they are willing to take.  The gov't is clearing going to need to borrow a lot of money, at least in the near term future, and if they want to borrow more money than people want to lend, rates will go up.  

Could someone talk about what is likely to happen to other interest rates in the event of bond rates jumping?  Will this cause other interest rates to also go up?

 

I'm already lost.

 

 Thanks Patrick for answering my question.

Amanda: let me try again, now that I'm less tired.  Currently the US gov't borrows money to make up the budget shortfall.  The mechanism for this borrowing is treasury bonds.  You give money to the gov't if it agrees to pay you back that money with interest.  The interest is determined by an auction.  

The auction works like this: the gov't announces how much money they are trying to raise (the most recent 30-year bond auction was for $14 billion). People then submit bids.  I'm not sure how this works, but here is my understanding from what I've read: you say how much money you will offer at a specific minimum yield (yield is the interest rate that the bond will earn).  So I might say "I will give $50 million if the interest rate is 3.327% or higher."  The gov't takes all the bids and sorts them by yield.  They start down the list until they have chosen enough bids to cover the amount they wanted to raise.  Everyone get the same yield as the highest accepted bid.

Simplified example:  I want to raise $150 and offer an auction.  The bids are $60 @ 5%, $50 @ 2%, $50 @ 4%, $20 @ 4.5%, and $30 @ 7%.  So the result would be an interest rate of 5%.  The people that bid less than that pay the full value they bid and get 5% interest.  The person who bid $60 pays $30 (since only half his bid was accepted) and get 5%.  The rest pay and get nothing.  

One statistic they use to see how well an auction went is the bid-to-cover ratio.  That is the ratio between the total of all the bids (in this case $210) to the amount that was accepted ($150).   This auction has a bid-to-cover ratio of 1.4.  

http://interestrateroundup.blogspot.com/2009/02/30-year-treasury-bond-au... is a blog entry (not by me) talking about the most recent auction. 

http://www.treasurydirect.gov/instit/auctfund/work/work.htm if you want more details or a list of recent auctions and results.

 

So to take a step back from the details,  the more money the gov't wants to borrow, or the fewer people that want to lend it, the higher the interest rate for bonds.  And from what Patrick said, the higher the interest rate on bonds will cause a higher interest rate on everything else as well.  

Amanda V's picture
Amanda V
Status: Gold Member (Offline)
Joined: Dec 31 2008
Posts: 262
Re: Where could interest rate go in the short and long term?

Thank you all so much for the effort all of you have gone to to explain it to me.  I suppose it doesn't help that I am not from the US so don't have familiarity with the way it works in the US.

Tell me though, why would the government raise money by selling bonds when they can just print money ?

The other thing is - there is and has been in the past quite a few threads speculating about house prices and interest rates and inflation.

Chris has many interesting articles in the Chrismartenson reports.  You need to be a subscriber but it is certainly worth it if you are interested in his opinion on all this or trying to second guess what might happen - his perspective and opinion is, as always, informative, well researched and interesting.  One summary he recently made is:

"I think the most likely outcome from this latest Fed move will be a declining dollar and the eventual, if not spectacular, return of both inflation and higher interest rates. " 

I hope I was allowed to copy and paste that one sentence, if not I suppose the moderator will come along and take it out!

It also helps the cause to subscribe.  And it just strikes me that a lot of these questions and discussions would benefit from his comments too.  Just a thought.

 

 

Farmer Brown's picture
Farmer Brown
Status: Martenson Brigade Member (Offline)
Joined: Nov 23 2008
Posts: 1503
Re: Where could interest rate go in the short and long term?

[quote-Amanda V]

Tell me though, why would the government raise money by selling bonds when they can just print money ?

Amanda,

The government sells bonds instead of printing more money because, to be fair, they have actually learned something from 3,000 years of fiat money creation disasters.  That's only half true, but let me explain.

The government sells bonds to anyone who is willing to buy them.  That includes foreign governments and private citizens.  As you must by now know, printing money is not good and even the government recognizes that.  When bonds are purchased with existing money, no new money is created.  However, the government is not all that committed to this idea.  Whenever there are not enough buyers, the government can be bailed out by the Federal Reserve (not part of the government).  The Fed does have the power to print dollars, and does so all the time to buy T-Bills.  Problem fixed.

It works the same way in all countries, except some do not go through the charade of licensing a Federal Reserve.  They find other ways of hiding from the public the fact that money is being printed into existence.  

plantguy90's picture
plantguy90
Status: Gold Member (Offline)
Joined: Jan 27 2009
Posts: 271
Re: Where could interest rate go in the short and long term?

Dont forget there are also issued govt bonds in existence, as well as state and municipal debt, corporates, etc.  Issued bond prices are affected by the current interest rate.  Bond prices move inversely to interest rates, rates go down, bond prices move up, rates rise, bond prices move down.  Existing bondholders do consider potential capital gains and losses of their bonds when making investment decisions.  Rates are at an all time low, therefore prices are at an all time high.  Profit is made when you buy low, sell high.  Back to the original question about the direction of interest rates, obvilously the FED is controlling short term interest rates by keeping them low.  Ben has threatened to print money to buy even the long end of the curve to keep those rates down.  But all that inflationary money puts pressure on bondholders to want higher rates to hold on to this investment, and existing bondholders are aware that prices cant rise much more, but can drop a lot more. 

A bit of digression: 

I was fascinated by bonds as a young man, enough I tried my hand at selling as a broker.  I remember we borrowed this line the big guys "Oh, Mr. Prospect, Ginnie Mae's and Fannies and Freddies aren't govt bonds and aren't directly guaranteed by the Govt, but the govt has a MORAL obligation to step in should these bonds ever fail, which is unlikely.  You know, if those AAA rated bonds ever fail, you'd be better off investing in sandbags and barbed wire!

I kid you not.  

   

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments