On Sept 18, with breathless anticipation accompanied with much fanfare, the Federal Reserve revealed to the universe that it was “lowering interest rates” by ½ percent. More accurately, it lowered the Target Range for the Federal Funds Rate by 1/2 percentage point to 4-3/4 to 5 percent, and would then utilize its banking magic to insure that the Overnight Bank Funding Rate settled into this new range, as previously explained here.
This distinction is important, as we need to be reminded every so often that while the Federal Reserve influences interest rates, it is the secondary markets, driven by the actual demand and supply for debt, that sets interest rates.
Which explains why the 10-year treasury yield, (which mortgage rates are derived from), has risen by 10 percentage points since September 18th, contrary to the expected 50-point decrease.
10-Year Treasury Yield, Days of September
Funny that so few are talking about this, which I interpret as “whistling past the graveyard”, because no one really wants to contemplate that the Federal Reserve has lost control, that try as they might, interest rates may not go down as most hope they will.
Why is the 10-year yield behaving so badly? Perhaps something to do with the record amount of Treasury debt in the market?
As can be seen in the graph below, while there does appear to be a historical correlation between the Overnight Bank Funding Rate (blue line) and the 10-year Treasury Yield (red line), the green line is that pesky line-item known as “Federal Debt.” Could it be that this record high level of debt is starting to have more influence on the 10-year Treasury Yield than the Federal Fund’s Rate?
The Federal Reserve could simply choose to create dollars, to buy up that excessive Treasury debt, to lower the supply, which would push down interest rates. But that would be inflationary, and per September’s data, the rate of inflation never actually reached the Fed’s stated goal of 2%. And it would be a course-reversal from the prior two years, where the Feds have been taking dollars out of the system by selling assets, reducing its balance sheet, bringing down the rate of inflation.
Would it really do this course reversal? Should it?
My guess is that as the out-of-control government spending continues unabated, try as the Federal Reserve might, for now, interest rates will remain higher than most would want them to be.
Furthermore, the Fed’s will not reverse course because they know that historically normal interest rates are preferable to returning to a higher rate of inflation.
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