The markets have such a short memory! For decades before 2000 the 10 year Treasury yield was always 2% to 2.5% over the inflation rate. And even that would have been considered a low real yield during earlier times.
Walter Bagehot, a 19th-century British journalist and editor of The Economist, wrote, "‘John Bull can stand many things, but he cannot stand two per cent.’ When interest rates fell to such a low level, investors reacted to the loss of income by taking greater risks.
The excellent book, " The Price of Time: The Real Story of Interest," by Edward Chancellor, shows how repression of yields by the Federal Reserve has caused real damage to the U.S. economy by encouraging the build-up of unproductive debt.
But financial repression has continued for 20+ years. The markets are so accustomed to low yields – addicted to low yields – that they expected them to last indefinitely. Even the “emergency” QE from the Covid years.
Low Rates Were Meant to Last. Without Them, Finance Is In for a Rough Ride.
Economists expected inflation and rates to stay low for years. With Silicon Valley Bank’s implosion, Wall Street is starting to reckon with how wrong that prediction has proved.
By Jeanna Smialek, The New York Times, March 16, 2023
If a number defined the 2010s, it was 2 percent. Inflation, annual economic growth, and interest rates at their highest all hovered around that level — so persistently that economists, the Federal Reserve and Wall Street began to bet that the era of low-everything would last.
That bet has gone bad. And with the implosion of Silicon Valley Bank, America is beginning to reckon with the consequences…
Many banks are holding big portfolios of long-term bonds that are worth a lot less than their original value. U.S. banks were sitting on $620 billion in unrealized losses from securities that had dropped in price at the end of 2022, based on Federal Deposit Insurance Corporation data, with many regional banks facing big hits.
Adding in other potential losses, including on mortgages that were extended when rates were low, economists at New York University have estimated that the total may be more like $1.75 trillion. Banks can offset that with higher earnings on deposits — but that doesn’t work if depositors pull their money out, as in Silicon Valley Bank’s case…
Everyone, policymakers included, spent years assuming that rates would not go back up…
Central bankers had previously hinted that they might raise interest rates even higher than the roughly 5 percent that they had previously forecast this year as inflation shows staying power and the job market remains strong. Whether they will be able to stick with that plan in a world colored by financial upheaval is unclear. Officials may want to tread lightly at a time of uncertainty and the threat of financial chaos… [end quote]
When I read “meant to last” I actually chuckled. Books like “Manias, Panics and Crashes” and “This Time is Different” clearly show the past cycles that resemble the extreme imbalances that can build up in markets and the bubbles that burst.
No, low rates were never “meant to last.” They were forced and had negative impacts that will unwind in the coming years.
The Fed will have to raise rates or inflation will increase again. It’s already way too high.
Wendy
