Video: Interest Rates are Confusing Investors. 5% Yield for the 10 and 30 Year US Treasuries. What Now?

October 24, 2023

Most investors and talking heads misunderstand interest rates.

The Fed (The Federal Reserve) is capable through the Federal Funds Rate (FFR) of influencing the short end of the curve, rates under 1 year. FFR has a current effective rate of 5.33%. This is far below the historical average, but way up from the 0% it was for much of the last 15 years.
This short-term rate does influence the longer end of the interest rate environment, with a delayed effect. The short-term rate highly influences borrowing costs, economic activity, and thus inflation. This impacts nominal GDP, both inflation and growth. GDP and inflation are what determine the longer-term interest rate environment. For example, lower short-term rates cause higher economic activity, causing higher inflation, causes higher long-term yields with a delayed impact. The inverse is also true.

Interest rates could still have an upward bias from here, though the largest increases are probably over. We believe that in a Nominal GDP (Gross Domestic Product) environment of 6% growth (3% inflation, 3% real GDP), a fair yield for 10 and 30-year Treasuries approximates this 6% nominal GDP on historic market-based pricing.

Other items influencing interest rates:

  • The federal deficit is $1.7-2 trillion per year with interest expense approaching $1 Trillion as rates reset higher.
  • The Fed has become a net seller of treasury bonds with QT (Quantitative Tightening). Over the last 15 years, the Fed’s balance sheet went from $800 billion to $8.9 Trillion with multiple rounds of QE (Quantitative Easing). In April 2022 it peaked and then started down with QT.
  • Buyers of US bonds are becoming weary and reducing US dollar and treasury holdings as fear of sanctions and an out-of-control US budget deficit make dollar holdings less safe. Gold is increasing its importance for global central banks.