munKNEE.com Your Key to Making Money
After a long period of very low interest rates following the global financial crisis the
central banks of the U.S. and U.K. are planning to gradually tighten their easy monetary policies as their economies improve. When their benchmark interest rates go up, interest rates elsewhere will go up to so should we worry if and when global financial conditions tighten?
The above introductory comments are edited excerpts from an article* by Hamid Faruqee (blog-imfdirect.imf.org) entitled Should We Worry About Higher Interest Rate?
The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), and www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), and www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Faruqee goes on to say in further edited excerpts:
The 2014 IMF Spillover Report…looks into this important issue—what to watch out for and who to watch out for as interest rates begin to normalize – and the answer depends on two sets of factors:
- what is going on in the originating source countries in terms of the underlying drivers behind higher yields—for example, whether or not stronger growth, say in the U.S. and U.K., is the main force behind higher interest rates and
- what is going on in the receiving countries—that is, how vulnerable they might be to higher borrowing costs.
Both these factors matter for spillovers as highlighted in the report.
Factors that drive yields higher—good and bad spillovers
Good spillovers are produced by higher interest rates and exit from monetary stimulus…when led by stronger growth prospects (real shocks):
- Interest rates tend to rise elsewhere, lifted by a rising tide of economic activity at home and abroad…[and]
- trade and capital flows tend to strengthen.
Spillovers then tend to be negative when interest rates move up faster than what is suggested by the real economy (money shocks):
- Interest rates elsewhere tend to go up more sharply as liquidity conditions tighten in major financial centers.
- Capital tends to flow out, especially from vulnerable emerging economies.
- Foreign activity is dampened.
Based on the report’s analysis, the chart below shows what have been the main drivers of higher U.S. long-term yields since the taper episode over a year ago.
Notice what happened last summer.
- Against a backdrop of low market volatility, low spreads, and high asset prices, mere talk by the U.S. Fed of tapering its purchases came as a monetary shock or surprise to markets (blue area)…[and] interest rates moved higher quickly.
- Market turbulence ensued.
- Negative spillovers were felt worldwide.
The problem is that the central bank may have had little choice: if it felt market expectations and risk-taking had become too one-sided, some course correction may have been needed.
Whether fully intended or not, Fed communications during the episode have clear lessons going forward.
- Given an unconventional starting point—low interest rates and large balance sheets—major central banks face complex challenges when it comes to normalizing smoothly.
- If markets get well ahead of themselves, financial stability concerns may require higher interest rates even if growth is not stronger. With recent market volatility and spreads falling again to low levels and asset prices moving up (some at all-time highs), this is something to watch out for.
What else matters for spillovers?
- Spillovers from higher interest rates depend on local factors too.
- During the May 2013 taper episode, for example, spillover effects were not all the same. Instead, effects differentiated across emerging economies depending on their fundamentals and policies.
- Notably, those with higher external deficits or lower reserves, higher inflation or weaker growth were harder hit. Their interest rates rose or currencies fell…more.
- During the May 2013 taper episode, for example, spillover effects were not all the same. Instead, effects differentiated across emerging economies depending on their fundamentals and policies.
- Moreover, risks can interact.
- Markets may reassess those economies with weaker fundamentals in the context of rising interest rates and tighter financial conditions.
- Thus, more vulnerable economies along these lines are the ones to watch out for going ahead.
- Markets may reassess those economies with weaker fundamentals in the context of rising interest rates and tighter financial conditions.
Bottom line
Should we worry about higher interest rates given the above? No, not if stronger growth is the reason… but the road ahead is a tricky one. Much will depend on how well the normalization process [i.e. tapering] can be managed. That is, how smoothly we can transition along a path to higher growth and interest rates.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://blog-imfdirect.imf.org/2014/07/29/should-we-worry-about-higher-interest-rates/
Follow the munKNEE!
- Register for our Newsletter (sample here)
- Find us on Facebook
- Follow us on Twitter (#munknee)
- Subscribe via RSS
Related Articles:
We’re doomed! Even if the economy were growing at a faster pace, it wouldn’t come close to offsetting the interest payments on our ever-expanding debt. As such, any sort of credit shock – either rising rates or a decline in the rate of debt expansion – will cause the system to implode. Let me explain why that is the case. Read More »
Everyone knows that interest rates are going to rise in the future so the real question is not whether they will rise, but when and by how much. [This article analyzes when that will most likely be.] Read More »
4 economic conditions need to be in place for interest rates to rise ahead of – and independent of – the Fed’s forward guidance. The economy met only one of those conditions to date but will likely meet all four by the end of the year…What follows is a status report on the four conditions. Read More »
Everyone and their mom is expecting long-term interest rates to rise now that the Fed is tapering its bond buying programs. I have a couple of problems with this line of thinking because, although it seems like reducing demand for a security (i.e. tapering QE) would result in a drop in price, when you really think about how quantitative easing works this makes no sense and, secondly, the market is telling us this makes no sense. Let me explain. Read More »
There is one vitally important number that everyone needs to be watching right now, and it doesn’t have anything to do with unemployment, inflation or housing. If this number gets too high, it will collapse the entire U.S. financial system. The number that I am talking about is the yield on 10 year U.S. Treasuries. Here’s why. Words: 1161; Charts: 2 Read More »
It seems that the past few years of falling interest rates have lulled a big part of the global economy into financing with variable-rate debt…[As such,] when interest rates go up (as they did last week), there’s a world-wide reset in interest costs that, best case, amounts to a tax increase on individuals and businesses and, worst-case, threatens to blow up the whole system. Read More »
What does it look like when a 30 year bull market ends abruptly? What happens when bond yields start doing things that they haven’t done in 50 years? If your answer to those questions involves the word “slaughter”, you are probably on the right track. Right now, bonds are being absolutely slaughtered, and this is only just the beginning. So why should the average American care about this? Read More »
The global financial system is potentially heading for massive amounts of trouble if interest rates continue to soar. So what does all this mean exactly? [Let me explain.] Read More »
If yields on U.S. Treasury bonds keep rising, things are going to get very messy. What we are ultimately looking at is a sell-off very similar to 2008, only this time we will have to deal with rising interest rates at the same time. The conditions for a “perfect storm” are rapidly developing, and if something is not done we could eventually have a credit crunch unlike anything that we have ever seen before in modern times. Let me explain. Read More »
[While]… I am not currently predicting an acceleration in inflation [I believe]…that the risk of interest rate instability is very real [given that] core inflation is already above a key benchmark that the Fed has staked its credibility on,. It should be of concern to investors that, despite economic growth being so anemic and overall resource utilization being so low (including human resources), there is currently very little margin for error on the inflation front. [In this article the author evaluates the danger that rising interest rates could potentially have on the U.S. economy.] Words: 2050 Read More »
The once unthinkable might become policy: negative nominal interest rates. Investors should care as they may be increasingly punished for not taking risks yet masochistic investors believe they may be the prudent ones given the risks lurking in the markets. What are investors to do, and what are the implications for the U.S. dollar and currencies? Words: 779 Read More »
Interest rates have been manipulated to keep them extremely low in an attempt to stimulate the economy but…unless deficits are dramatically reduced…. interest rates will eventually rise and government interest expense will double or triple from the amounts being paid today. That potentially triggers a debt death spiral, where government has to borrow more than otherwise expected. It also raises the credit risk and could ratchet interest rates up again. It has happened to Greece, Portugal, Spain and other European countries already this year and could well happen in the U.S. too. Words: 595 Read More »
Everyone who purchases a Treasury bond is purchasing a depreciating asset. Moreover, the capital risk of investing in Treasuries is very high. The low interest rate means that the price paid for the bond is very high. A rise in interest rates, which must come sooner or later, will collapse the price of the bonds and inflict capital losses on bond holders, both domestic and foreign. The question is: when is sooner or later? The purpose of this article is to examine that question. Words: 2600 Read More »
Countering Krugman’s argument that today’s low interest rates show that no one is worried about lending money to us and, therefore, that we should borrow and spend our way to prosperity, Ferguson argues that today’s interest rates are irrelevant. When countries get into trouble, he says, they get into trouble quickly – the way Greece and other European countries have. Taking … Read More »
Right now, interest rates are near historic lows. The U.S. government is able to borrow gigantic mountains of money for next to nothing. U.S. consumers are still able to get home loans, car loans and student loans at ridiculously low interest rates. When this low interest rate environment changes (and it will), it is going to absolutely devastate the U.S. economy. Without low interest rates, the U.S. financial system dies. [Let me explain.] Words: 1529 Read More »
Brace yourself for one of the greatest interest-rate surges in decades — beginning first in the long-term Treasury markets … later spreading to shorter term Treasuries … and ultimately enveloping nearly every loan, debt, credit, and money market instrument on the planet. This rise may not begin with great fanfare, nor will it immediately upset the apple cart of the economic recovery, but with the march of time, it WILL gain momentum and reach critical mass. Words: 614 Read More »
