Dollars and Jens
Monday, November 23, 2009
low interest rates
I keep finding things in this article about T-bills trading at par that spark responses from me. Here's one I noted to my brother in email:
Equity investors say they have history on their side. The S&P 500 rose an average 8.4 percent in the six months before the last five increases in the Fed’s target rate for overnight loans between banks and added another 82 percent in the bull markets that followed, according to data compiled by Bloomberg. Shares typically rise before central banks push up interest rates because markets anticipate economic expansion first.
Now, there is in fact some reason to believe something like this would happen; the fed finally raises rates when it sees the economy is finally going to start improving, and the stock market can go up for the same reasons. Insofar as it would be commonly known or suspected when the Fed is going to start raising rates, though, this is exactly the sort of pattern that holds until it doesn't, and I would be cautious about regarding something like this as useful trading advice, at least without further context.
“If money is all going into short-term securities, at some point, investors will say ‘enough of it’ and the next incremental change will be for money to chase riskier assets.”

I fear he's right. Not that I'm sure risk premia are too low right now, but there's a long history of people in low interest-rate environments getting stuck on the notion that the higher returns they used to get should still be out there, and bidding up higher-risk securities until the yields go down, prompting even more risk-taking, often to the point where the risk-premium is probably negative, until it gets unsustainable. If investors accept that they do not have a moral entitlement to 5-10% returns, they — and everyone else — will probably ultimately be better off.

Incidentally, I've bumped into smart people who seem to think real interest rates shouldn't, by some law of economics, be negative. Most standard models suggest that during times of contraction they should; even people who prefer things now can be induced to save money at negative interest rates if they expect to have less income in the future, or even if there's sufficient uncertainty about the future. I'm not sure where this idea that real discount rates should always be positive comes from.

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