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Is the Fed losing control of interest rates?

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May 08, 2009 – Comments (3)

I have mentioned numerous times in the past that one of the key metrics that I am closely following is interest rates. They have been making my spider sense tingle lately (either that or it's all the beer that I had last night). 

The Federal Reserve has control of the short end of the yield curve where rates are still close to zero, but longer term interest rates have been slowly creeping higher, and higher.

This steep yield curve is relatively good news for banks, who are able to borrow money practically for free and lend it at increasingly higher rates.  I said "relatively" good because higher long term interest rates are likely bad news for the economy.  Low long term rates stimulate economic activity becuase they encourage businesses and consumers to borrow and they keep their interest expenses low.  Conversely, high interest rates act as a drag on economic activity.

One key interest rate that many follow is 10-year Treasuries.  They traditionally have been very closely linked to mortgage rates.  Ever since the 10-year plunged to around 2.5% when the Fed announced that it will begin buying Treasuries in an effort to lower rates in Mid-March the it has been steadily rising.

On a personal level, I actually welcome higher interest rates.  I already locked in a 30-year fixed mortgate at a great rate, my bonds have reasonable maturity dates, and it's annoying having my emergency funds sitting in a savings account earning virtually zero interest. As long as I hold my bonds to maturity, I can take the interest from them andinvest it in new, higher yielding instruments.

Of course, there's a limit to how high I want rates to go.  If the market begins to choke on all of the debt that the U.S. government has to issue to finance its growing budget deficit and interest rates continue to rise it is bad news for the economy.

All investors should keep an eye on where interest rates are headed.

Treasurys Drop On 30-Yr Bond Auction; 10-Yr Yield Above 3.3%

Deej

3 Comments – Post Your Own

#1) On May 08, 2009 at 6:07 AM, TMFDeej (99.41) wrote:

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#2) On May 08, 2009 at 6:27 AM, whereaminow (20.57) wrote:

Is the Fed losing control of interest rates?

The better question is Can the Fed control interest rates?  That is the inherent assumption behind their charter, that the Fed can control interest rates (the price of money) by increasing or decreasing supply. 

So, the answer is no, the Fed is not losing control of interest rates. It never controlled them in the first place. It manipulates them, but price manipulation in any area of the market, whether it's the price of money or the price of spoons, only distorts the market.  Manipulation can only work for so long.

The Fed is already toying with idea of targeting negative interest rates in order to combat the problem that they've caused. That will be amusing to watch, if you enjoy destructionism.

David in Qatar

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#3) On May 11, 2009 at 1:01 AM, kaskoosek (70.89) wrote:

Euro rises to 7 week high

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