As we mentioned in a previous blog post— around the water cooler — an item of great attention in our office is watching the 10 year yield. I know…. watching interest rates sounds about as interesting as watching paint dry or grass grow. Still, the implication of risk-free money continued fall —from what we already considered absurd low of 2.2% at the end of 2014— has been a source of great conversation around the office. Now, 10 year rates are less than 2%. In other words, long term bond investors are willing to get less than 2% return on their bond purchases, even when investing their money for 10 years or more. Given a historical average inflation range between 2% and 3%, this <2% return for treasury bonds is essentially meaningless.
A 2% return might mean something if interest rates looked like they were going to fall. Consider, the short term interest rates are defined by the Federal Reserve and they are widely expected to climb by the middle of the year; the best projections of FOMC guidelines and futures market estimates suggest a short term Federal Funds rate between 0.75% and 1.25% by the end of 2015. The short term rates usually represent a floor for interest rates (unless we have a rare inverted yield curve) so there has to be some upward pressure on rates, even if the yield curve gets flatter.
A 2% return might mean something if there was no inflation. Consider that unemployment growth has been continually solid all year, with implications for future inflation and potential economic growth; this should also provide upward pressure on long term rates, since the Fed’s primary function is to keep inflation in check by boosting rates.
This leaves us with one remaining supposition: a 2% return is acceptable to investors because they are so nervous about investing elsewhere — cash, stocks, alternatives — that <2% return to “park” their money is just enough. This is not an optimistic position.