Economic Meltdown 2.0

I have hinted at treasury rates being a litmus test for the economy.  Econintersect Author Doug Short produced a chart yesterday which drove this point home with a vengeance.

10 year treasury is at record lows.  Why would an investor lock in 2.08% money return for ten years.  The only answer rattling around is that too many believe this is the best they will get.

If this were an investing post, it could be argued that the sheer quantity of treasuries steals investments from equities or real estate – and is playing a major role in the world equity market meltdown.  If this was an opinion post, I would argue the lunacy of a sovereign state which has its own currency to “borrow” money.

But analysis posts at Global Economic Intersection explore economic events, and try to provide perspective.

A paragraph from the last statement of the FOMC:

The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The longer the Federal Funds rate remains at low levels, the more endemic this low rate becomes in the economy.  The USA borrows for various time periods from days to 30 years.  The longer rates are low, the higher the percentage of long term treasuries outstanding are at “exceptionally low rates.”

In other words, IF the rate would rise – the existing holders of treasuries would find the value of their holdings worth less.  Rising interest rates cause bond holders to take haircuts.

The same holds true for other debt including mortgages or car loans – as all debt is linked to treasuries.  Rising interest rates would cause banks or other debt holders to take haircuts.

So to have debt buyers to buy a 10 year treasury at 2.08% means they are betting with their wallet this is the best return they will see in the next 10 years.

Many economists argue that low interest rates spurs economic growth.  Whilst true in the short term, it likely is creating an expectation headwind in the longer term that the economy may not grow.  Whether this is true or not is academic – as the market is saying 2.08% return on investment is good.

This low rate of return says the economy will not grow – and will likely contract (ala Japan).   This is the investor’s long term economic forecast.

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