The Interest Rate Mystery

Samuelson opines about the state of interest rates in the US in today’s Washington Post :

The Mystery of Low Interest Rates

Something strange happened on the way to higher interest rates: They declined. We’re talking about rates on long-term mortgages and bonds. These rates truly affect the economy, because they influence housing and business investment. Most economists expected them to rise. But no. Last June rates on 30-year fixed mortgages averaged 6.29 percent; now they’re about 5.7 percent. Federal Reserve Chairman Alan Greenspan recently called the declines a “conundrum”. Equally puzzling is whether the declines guarantee a healthy economy — or suggest a speculative “credit bubble”.

Samuelson mentions a few possible explanations: maybe it’s due to weak business investment (but does recent evidence really support that argument?); or because the bond market is expecting an economic downturn (but why would bond market participants expect that when stock market participants clearly don’t?); or my favorite explanation, the massive inflows of foreign capital, primarily from Asian central banks, that have been financing the US’s current account deficit.

But perhaps this mystery will disappear on its own. Over the past couple of weeks long-term interest rates have begun a significant march upward, raising yields on the 10-year government bond from about 4.1% three weeks ago to almost 4.4% today. A bit more of that and we will no longer be puzzled by the behavior of interest rates… and instead, will simply have to focus on the consequences.