Interest Rates

We thought it very timely to comment on interest rates. This sketch is the first of a series. The topic is sure to put a bunch of folks quickly to sleep; the irony of course is that we’re all impacted one way or the other by these pesky little things. They’re key stuff. The better grasp we have as to causality and direction, the better shape our personal balance sheets.

OK. Where to start? How about the near meltdown of Q4, 2008? We all remember that. The guy down the road with three cars up on blocks in his front yard, falls behind in his mortgage payments, and the economy of Iceland implodes. Whoa now! I'm missing a few pieces of this puzzle myself, but hey, that about wraps it up.

A lot of lousy mortgages were handed out to this guy and his drinking buddies. P.J. O’Rourke, always the tutor, takes it from there: "Wall Street looked at the worthless paper and thought, ‘How can we make a buck off this?’ The answer was to wrap it in a bow. Take a wide enough variety of lousy mortgages--some from the East, some from the West, some from the cities, some from the suburbs, some from shacks, some from McMansions–bundle them together and put pressure on the bond rating agencies to do fancy risk management math, and you get a ‘collateralized debt obligation’ with a triple-A rating. Good as cash. Until it wasn't."

So that was a shock of the first order. Indeed, come mid-Dec/08 we find Fed Funds at 0.25%, the 2yr Treasury at 0.92%, the 10 year at 2.10% and the 30 yr at 2.60%; these were collapsed levels. Why? And, we find the dollar in the cellar, one Euro buying $1.4446. But so what? What’s all this mean? What’s "Fed Funds" and what’s the two year? Why should we care? And the Fed was up to something then too. What was it?

Change was compressed into a very brief time frame during this period. This provides a useful lab for us to fetch a notion of the dynamics impacting interest rates, our single purpose in this exercise. Once we do that we can develop a view for the direction of interest rates, the course of least resistance over the near term. Better than a stick in the eye any day.

Robert Craven