Where Interest Rates Are Headed

[msi]

The Fed meets on December 16th. Interest rate futures suggest interest rates falling by 50 bp.

http://www.theglobeandmail.com/servlet/ ... streetwise

and more details http://www.clevelandfed.org/research/da ... /index.cfm

What do you think and if they lower them, will they stay low for a while similar to Japan, or will they need to be sharply increased at some point?

[Valuethinker]

The Fed meets on December 16th. Interest rate futures suggest interest rates falling by 50 bp.

http://www.theglobeandmail.com/servlet/ ... streetwise

and more details http://www.clevelandfed.org/research/da ... /index.cfm

What do you think and if they lower them, will they stay low for a while similar to Japan, or will they need to be sharply increased at some point?

There's no way of telling.

But my guess is low, and stay low for an extended period. The excesses that have built up in the US (world) economy will not go away in a hurry. A long period of low or no economic growth and extended workout of the problems in financial markets is in order.

[msi]

The Fed meets on December 16th. Interest rate futures suggest interest rates falling by 50 bp.

http://www.theglobeandmail.com/servlet/ ... streetwise

and more details http://www.clevelandfed.org/research/da ... /index.cfm

What do you think and if they lower them, will they stay low for a while similar to Japan, or will they need to be sharply increased at some point?

There's no way of telling.

But my guess is low, and stay low for an extended period. The excesses that have built up in the US (world) economy will not go away in a hurry. A long period of low or no economic growth and extended workout of the problems in financial markets is in order.

What do you think about the part with MM funds breaking the buck, though?

there was a widespread belief that the Fed would not cut further, in part because overnight rates that were well below 1 per cent would pose enormous strains on money markets. The specific worry was U.S. money markets funds would ‘break the buck,' as a combination of low rates of their investments and administrative expenses ate into assets.

Well, the Fed is now expected to be more concerned with kick-starting a moribund economy than helping out money market funds.

Think that's a realistic concern or...?

[cmarino]

The Fed meets on December 16th. Interest rate futures suggest interest rates falling by 50 bp.

http://www.theglobeandmail.com/servlet/ ... streetwise

and more details http://www.clevelandfed.org/research/da ... /index.cfm

What do you think and if they lower them, will they stay low for a while similar to Japan, or will they need to be sharply increased at some point?

There's no way of telling.

But my guess is low, and stay low for an extended period. The excesses that have built up in the US (world) economy will not go away in a hurry. A long period of low or no economic growth and extended workout of the problems in financial markets is in order.

What do you think about the part with MM funds breaking the buck, though?

there was a widespread belief that the Fed would not cut further, in part because overnight rates that were well below 1 per cent would pose enormous strains on money markets. The specific worry was U.S. money markets funds would ‘break the buck,' as a combination of low rates of their investments and administrative expenses ate into assets.

Well, the Fed is now expected to be more concerned with kick-starting a moribund economy than helping out money market funds.

Think that's a realistic concern or...?

This was a concern during the previous period that rates were at 1%. Most money markets paid out essentially nothing for a year or two. It has nothing to do with the sort of "breaking the buck" that is really a concern, which occurs when people default. The issue here is that the return on investment might sink below the expense ratios of the money market funds, if they're in the ~0.5 - 0.75% range.

[traineeinvestor]

The other issue which arises if rates fall to very low levels and stay there for any length of time is the effect subsequent increases in interest rates have on holders of debt securities - pension funds, money market funds etc. In effect, the lower interest rates go the greater the cost of subsequent increases.

"breaking the buck" becomes more of an issue when interest rates are raised than when they decline.

[Valuethinker]

There's no way of telling.

But my guess is low, and stay low for an extended period. The excesses that have built up in the US (world) economy will not go away in a hurry. A long period of low or no economic growth and extended workout of the problems in financial markets is in order.

What do you think about the part with MM funds breaking the buck, though?

there was a widespread belief that the Fed would not cut further, in part because overnight rates that were well below 1 per cent would pose enormous strains on money markets. The specific worry was U.S. money markets funds would ‘break the buck,' as a combination of low rates of their investments and administrative expenses ate into assets.

Well, the Fed is now expected to be more concerned with kick-starting a moribund economy than helping out money market funds.

Think that's a realistic concern or...?

It's got to be a concern for the Fed, the US having had to bail out MMFs once.

Maybe they have to wait until investors get used to the idea that MMFs don't really provide a return. That will slowly lead to them decreasing in popularity, by which time hopefully companies will be able to borrow from banks again.

[cato]

The Fed meets on December 16th. Interest rate futures suggest interest rates falling by 50 bp.....

This is really academic or irrelevant, since they have already driven the rate way below that through open market operations:

http://www.federalreserve.gov/releases/h15/current/

The only important info from the meeting is guidance on future direction.

[nisiprius]

One of the nice things about savings bonds, both I and EE, is that they only set the interest rate twice a year, and they just set it... to 0.7% real for series I (1.30% nominal for series EE; I believe, but haven't checked, that the EE still jumps to double face value at 20 years which if true about be about 3.5% annual if you care to hold them that long).

It might be good to make a mental note around March, because if interest rates have dropped much by then, savings bonds, particularly series I, might actually be interesting.

This wouldn't be the first time that interest rates dropped significantly during the period between savings bond rate adjustments, and that bonds that looked "meh" at the start of the period looked pretty good by the end.

[shelanman]

Nisiprius,

I have a feeling that the Oct 1 -> Apr 1 6-month inflation index will be sufficiently negative to make I-bonds with a 0.7% fixed component rather uninteresting.

My money's currently on the I-bond fixed component being increased in May again (because I think that with a fixed rate of only 0.7% -- or even a full 1% -- will have a 0% total return, and I think that they'll raise the rate enough to get the total return at least a little above zero.

If we have net-zero inflation from Nov 1 -> Apr 1, then the inflation component of the May I Bonds would be -2.28%. November will probably have negative CPI growth as well.

I doubt it will stay that way... we've printed so much money that as soon as people start transacting again, inflation is going only one way, and not down. How long it will take to get people to transact business again? who knows. But I doubt it will happen in 2008, and there's a reasonable chance that Q1 '09 isn't going to be that happening either.

I'm expecting May-Oct '09 I-Bonds to be decent long-term buys, because I expect the total return for the first 6 months to be between 0.25% and 1% and I expect that CPI-U will not increase much between now and when they do the next rate set.

Of course, they could issue I-bonds with a 0% total return and significantly under-water fixed rates... ya never know.

[chaz]

The Fed will probably cut the interest rate by 50 basis points to help the banks with liquidity.

[Asterix]

Since you can never lose principal on I-bonds, even in a deflation state where you earn no interest, your purchasing power increases. I.E. the 100$ you get back when you cash the bond is 'worth' more than the $100 you spent buying it. Small solace, but still. Plus, if deflation does continue and a year or more passes with no interest, you can redeem the bond at any point without penalty, as there is no interest to penalize.

I-bond fixed yield combined with inflation correction tend to follow the Fed funds rate, with some delay - see here for example data. Thus, if deflation continues until May and we maintain a non-zero Fed funds rate, we could see 3% fixed i-bonds again. I agree the current 0.7% is uninteresting.

Since the annual limit on I-bonds is $5k/year, this sort of thing only really benefits us small-fry investors. Until normal Treasuries come out of the gutter I don't see TIPS auction yields moving up much.