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Article On Fed Impact On Long-Term Interest Rates

See for the original.

Main interesting snippet clipped below:


The crucial and usually unreported point is: Long-term interest rates have seemed almost impervious to the Fed and what it's been doing.

Consider this curious fact: When the Fed first announced its first round of "quantitative easing" back in December of 2008, it bought mortgage-backed securities and bonds issued by the quasi-governmental housing agencies, Fannie Mae and Freddie Mac.

The idea was to bring down mortgage rates from their then-current rate of 6 percent (for a 30-year fixed rate loan). If the housing lenders could borrow money more cheaply because lenders like the Fed would provide it, they could pass on lower interest rates to home buyers.

In March of 2010, the Fed finally ended the program. Mortgage rates had indeed come down a bit -- down to 5 percent. So perhaps that was an indication that the Fed's plan had in part succeeded. But the Fed was about to stop buying, presumably figuring the housing market was about to return to normalcy. The risk: that mortgage rates would go up.

"When the Fed stops buying and cedes the playing field to private investors," CNN reported at the time, "they will almost surely demand better return for their risk." "'Rates are going to be higher than they are now,'" said Brinkmann." (CNN was quoting Jay Brinkmann, chief economist for the Mortgage Bankers Association.) "How much higher is the question," concluded CNN. And that was the only question most observers were asking.

So, what happened to mortgage rates after the Fed stopped buying? To the shock of everyone who thinks the Fed determines long-term interest rates -- that is, just about everyone who comments on such matters -- the rates wentdown. And down. And down some more -- to today's 3 percent or so.

That was the record of QE1 (the policy, not the boat). QE2 began in the fall of 2011. With the economy still a-swoon and unemployment unacceptably high, the Fed announced it would begin buying bonds again. But this time, the Fed would buy not mortgage securities but Treasury bonds: US government debt. Massive amounts of it. Interest rates would go down. The economy would revive.

But again, let's look at the numbers -- what actually happened. In November of 2010, when QE2 kicked off, the interest rate the Treasury paid to lenders in order to borrow money for 10 years was 2.67 percent. So when the "lender of last resort" -- the Fed -- stopped buying Treasuries at the end of June, 2011, the interest rate on the 10-year bond had to be lower, right? Okay, you take a guess: how much lower? What, in other words, was the effect of the Fed buying "Treasuries" to lower U.S. interest rates?

Actually, the effect was, as they say in the world of medicine, "paradoxical." On June 30 of 2011, the interest rate the U.S. Treasury had to pay to borrow money for 10 years was 3.18 percent. The interest rate had not gone down, butup -- it had gone up substantially.

And now, at last, we have QE3. It was formally announced on September 13 of 2012. The 10-year interest rate at the time? 1.75 percent. The 10-year rate today? 1.63 percent. A slight change at best.

The punchline with regard to the all-important long-term interest rates should be clear: the Fed's influence is debatable.

Playing off posts on this page by economic historian Jim Livingston, let me offer this possibility: that the world has what Fed chairman Ben Bernanke dubbed, in 2005, a "global savings glut." In short: too much capital, chasing too few investment opportunities. It's an argument for another day, another post. But think about it. Final question, then: if the Fed isn't determining long-term interest rates, who or what is?