“The Federal Reserve has neither the obligation nor the ability to hold interest rates on Treasury bonds at a certain level. However, it is the policy of the Federal Bank of America to protect the market from wild swings in bond prices due to speculation and panic.” These are the minutes of the September 1939 Federal Reserve meeting. Today, there is no incongruous feeling.
When will the 10-year Treasury rate break 2 percent, or is it likely to break 3 percent? This is what the market is concerned about right now, as it determines when to bottom buy gold, short commodities and add to “core assets.”
In response to the Fed’s “inaction”, the market has repeatedly made a “die for you” posture. The Fed should be most bothered by the prospect that the medicine will not stop. Indeed, the Fed is likely to welcome the current reflation and rise in long-end interest rates. The Fed was almost out of ammunition after COVID-19. Markets will learn to live with all this over time. For the Fed’s Daoist recuperation is likely to remain for a while.
PCE core inflation was 1.45% in January, and while the curve of inflation expectations is steeper in the expert survey, longer-term inflation expectations show no signs of overheating. The truncated average PCE inflation is even in falling territory, the output gap is still not negative and unemployment is still around 6%. None of these factors support the Fed’s view that inflation will get out of control. Although the Fed did not announce an average inflation target until last year, the new Taylor rule, adjusted for average inflation, has been better at matching short-end money market rates since the Fed began its rate-raising cycle in 2015. In addition, the Fed’s inaction is also an achievement. Expanding the balance sheet to support lower interest rates and government bond prices would, in turn, push up inflation expectations. Of course, in an effort to calm market expectations, the Fed also stressed, as it did more than 80 years ago, that it would “put out the fire if market disorderly conditions or continued strains in financial conditions threaten the achievement of our objectives.” After all, any rise in interest rates beyond a certain point can damage the bond bulls’ balance sheet, including the Fed itself. By the end of 2019, the Fed had become the largest single contributor to Treasury securities, followed by mutual funds. Foreign ownership accounted for a total of 41 percent, and Japan has surpassed China as the largest holder.
Data: CBO, Federal Reserve, Orient Securities Wealth Research Center
While we have emphasized in our articles since October that reflation will be a longer-term macro story, we have argued that Treasury rates do not have sustained upward momentum. In addition to the Fed’s vast Arsenal of tools at its disposal, history suggests that only endogenous growth driven by the technological revolution or runaway inflation can produce a sustained rise in interest rates. At the moment, neither exists.
Given history, the low interest rate environment since 2008 May simply be historical inertia.
1. Long wave of US interest rates
“History can demonstrate more varied interest rates over a larger area, while the focus remains on the main long-term and short-term market rates for the best credit in the most advanced commercial countries”  because they are the anchors of asset pricing. Before and after the Glorious Revolution, it was the interest rate of Dutch and British government bonds, and after the First World War, it was the interest rate of US government bonds. The interest rate of other countries’ government bonds can be obtained by adding the risk premium to the yield of the corresponding maturity Treasury bonds of the US. Therefore, since the end of World War II, the interest rates of market-oriented and open economies have been moving in step with each other, and the monetary authorities’ choice of raising interest rates and lowering interest rates has also been correlated to a certain extent. This is what Toshiki Tomita describes as “the role of the Big Dipper” (Tomita, 2016, p.20).
After the Revolutionary War, the United States retained the British tradition of credit and interest. Business loans are legal, and personal consumer loans are considered shameful. Modest interest rates are welcome, and usury is forbidden. The 6% interest rate cap set by British usury laws remained in place in most American states until it was repealed in the 1950s. As a result, for more than 150 years, high-grade long-term bonds in the United States rarely yielded interest rates above 6%. From the Revolutionary War to the end of World War II, the long-term trend of interest rates in the United States was downward, with progressively lower highs and lows (Figure 2). From this perspective, the low interest rate environment since 2008 May simply be historical inertia.
Explanation: The fourth round of Kangbo was interrupted by the “stagflation” in the 1970s and continued in the early 1980s. There are also views regarding the ICT industrial revolution as not the fifth round of Kombo.
Since the 1930s, nominal interest rates on high-grade bonds in the United States have experienced three complete long cycles:
The first long period was from 1832 to 1899 and lasted 67 years. The interest rate peaked in 1861 (6.82%), and the period of rise and fall was 29 years and 38 years respectively . By 1899, interest rates (3 per cent) had fallen by 56 per cent from their peak.
The second long period was 47 years from 1899 to 1946. Interest rates peaked in 1919 (5.4%), followed by a rising cycle in the first 20 years (a bear in bonds) and a falling cycle in the next 27 years (a bull in bonds). In 1946, the historic low for US interest rates before the 2000s, the interest rate on long-term Treasury bonds was just 2.1%. Both world wars are turning points in the cycle, but World War I is the high turning point and World War II is the low turning point. The low interest rates of the second world war were out of line with history, but those of the two wars have been in line with international politics and economics. After the First World War, the international politics fell into the crisis of hegemony disintegration (Kindleberger Trap), the economy suffered from the Great Depression, and the golden age under the American administration after the Second World War.
One seminal event was the establishment of the Federal Reserve in 1914. It changed the structure of money markets and could explain low interest rates during the second world war. Through the pooling of reserves and the establishment of a lender of last resort facility, volatility in short-term money market interest rates has been significantly reduced. The Fed was originally set up to facilitate short-term business transactions, but the outbreak of the first world war gave it some political responsibility. The New Deal, the Great Depression and the second world war all reinforced this task. “Promoting full employment with very low interest rates has become a political goal” . From 1937  until March 1951, when the Ministry of Finance reached an agreement with the Federal Reserve to withdraw the policy of supporting the price of Treasury bonds , the Federal Reserve implemented the policy of supporting the price of long-term Treasury bonds (Figure 3, Toshiki Tomita, 2015, p.544) . Low rates can also reduce the interest burden on the Treasury, just as the interest burden (interest payments/revenue) has fallen since 2008, even as the stock of Treasury debt has risen. The Fed has contributed to fiscal sustainability.