Pondering Interest Rates
- Oct 01, 2014
If you were to ask 100 economists what is going to happen to interest rates over the next two to three years, I am certain 95 would say they are going to rise, and I might have agreed with them a month ago. But some statistics and metrics give reason to question their expectation.
For instance, why should the 10-year German Bund be priced at 0.95 percent and our 10-year bonds be at 2.49 percent? That’s basically a 162 percent difference in yield! Does that properly represent the risk premium between a German and a U.S. bond? Not in my opinion.
We can apply the same analysis to the following comparisons:
U.S. 10-Year Bond (as of 9/30/2014) 2.49%
Most of the above countries, if not all, have weaker economies and larger debt loads, and some have received International Monetary Fund or European Union bailouts within the last few years. Something doesn’t make sense here. I don’t see open market and free pricing in the risk yields above. Hence, I would conclude that there is as much a chance that our interest rates will decline, so that they are in parity with countries with similar risk profiles, as that they will go up.
I understand interest rates are at 40-year lows and I was a believer — actually, a disciple — with the school that rates would rise soon. My firm has been making all of its financing and capital decisions based on a projected rise in interest rates over the short term and has been paying a premium to hedge this risk.
Yes, rates will rise. But now I am not sure it will be so soon!