Okay, so the Fed may finally start raising the one-day rate of interest, otherwise known as the Fed Funds rate. The financial news media and the stock market seem to be infatuated with this possibility.
Whenever good economic news is reported, the stock market falls. Wouldn’t you think that American stock investors would be happy when 300,000 people get jobs in one month? So why does the market decline when it receives good economic news?
The answer is that the stock market has been propelled upward to record highs in the past five years because of artificial stimulation from zero interest rates. It’s a good gambit. Borrow money for virtually nothing and then invest it in stocks that continue to go up with each passing day that the Fed allows it.
So you have stock prices at artificially high levels and bonds at artificially high levels. Investors fleeing from high-priced stocks and bonds have been pushing up commercial real estate values to prices even higher than the golden year of 2007.
So is this the end of the “low-rate environment?” I don’t think so.
Do you think that investors will stop buying our Treasury bonds because they think prices might fall? I don’t think so.
Why? Because there is nowhere else for bond investors to go.
The rate of interest on a U.S. Treasury ten-year bond is about 1.9 percent. Compare this with bond yields in other countries around the globe.
Bond investors have no place to run. The U.S. ten-year bond is still very attractive compared with Europe and Japan. It’s hard to imagine earning less than one-half of 1 percent for ten years on a Swedish or German bond. How about a whopping quarter of a percent for a Japanese bond?
Then of course there is the ten-year Swiss bond that actually costs you to own it. Maybe you buy it for $1,000 and ten years later you get back $925. I doubt most financial calculators in the world actually have a negative interest rate button.
For you commercial real estate types, plug in a negative interest rate to calculate the present value of a commercial property. I’m guessing the poor little machine will spin for a second and then shut off.
I read recently that up to 16 percent of government bonds around the world now offer negative interest rates.
In this environment, I doubt increasing the one-day borrowing rate will have much impact on the ten-year U.S. bond that largely determines borrowing rates for commercial real estate and residential real estate mortgages.
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