Former President George W. Bush used to refer to Russian President Vladimir Putin as “Pooty Poot.” Since his entry into Ukraine, I’ve been calling him “Vlad the Invader” after Vlad the Impaler, a particularly cruel 15th century Romanian king whose family name was used by Bram Stoker in his vampire novel, Dracula. Anyway, I found it very interesting when one financial expert recently attributed roughly one quarter percentage point of the recent decline in long-term interest rates to the uncertainties arising from Putin’s invasion of Ukraine.
During the past year or so, the yield on the all-important 10-year U.S. Treasury note has gone from 1.6 percent in April 2013 to 3 percent a little later. In mid-May, it fell back down to 2.5 percent. How much of the recent decline is really due to Vlad the Invader is anybody’s guess, but it is worth taking a look at other major forces. Long-term interest rates are driven by a number of factors whose relative importance can shift at any moment. Slower economic growth usually means lower bonds yields. When business activity is sluggish, the supply of bonds, mortgages, etc., will rise less rapidly than when growth is brisk.
Related Article: It’s Electric! US Savings Bonds go “e”
Inflation also influences bond yields since when expectations are low investors require a smaller premium to get them to part with their money. Then there are the Federal Reserve’s purchases of three trillion dollars of Treasury bonds and mortgage-backed securities over the past five years through the Quantitative Easing (QE) program. By dramatically increasing the demand for these securities, the Fed has lowered interest rates below where they would otherwise be. It was the talk about scaling back on these purchases (the so-called “tapering”) that pushed the 10-year up from 1.6 percent last year. Starting this past December, the Fed began reducing the amount of new purchases made each month and should be finished buying by late this year.
Back to Pooty Poot. Say what you want, but the huge, liquid U.S. financial markets are a safe haven in times of actual or threatened foreign turmoil. When Europeans are worried about Crimea and what the whole thing might mean for their economy and banking system, they can move funds to the safety of U.S. Treasury bonds. The increase in demand brings down U.S. interest rates. OK, so where does this all lead us? The answer is higher bond yields. The latest Wall Street Journal survey of economic forecasters has the 10-year note yield rising from the present 2.5 percent to 4.3 percent by December 2016. The economy is expected to perform a bit better than it did last year, with unemployment falling to 5.4 percent by then. And inflation, as measured by the Consumer Price Index, will rise a tad to 2.3 percent. And last, but not least, the situation in Ukraine should be far more stable. Finally, do you think Putin had a nickname for President Bush?
Related Article: The Economic Review: Lotto & Other Long Shots + The Federal Deficit