The Yellen Fed has been painfully slow to ratchet rates up to levels required by the US economy. As “Davidson’s” chart below shows that historically the Fed Fund rates had been set ~.2% away from the 10yr. Treasury. Today that difference is ~1%. It’s far too early to quantify exactly the ramifications of this but one has to wonder:
- Has the prolonged recovery (now 9 years) been due to the artificially low rates
- Has the fact the recovery was arguably the most anemic in US history also due to artificially low rates
- Is the fact the US economy is now accelerating due to rates finally (and grudgingly) being raised?
- There has been an unprecedented amount of gov’t backed debt sold with these low rates. Is it a bubble and will it pop slow as investors sell these bonds? Or will they pop it and sell in a rush?
- Where does this money go then?? Is this the reason for the US stock market’s strength as investors move from bonds to equities?
When this experiment is over of course the answers will be crystal clear (everything is in hindsight). One thing is clear though, the rate spread has never been this large and things like this affect investor behavior. It also adds a certain layer of unpredictability in credit markets and when you have a market that size, sudden ripples there can cause major waves across other asset classes.
The Fed is now playing catch with rates….a raise now is virtually certain…