Interest Rates, A Drama Queen, and Napoleon
Oh boy! 
Another article about low interest rates. For the better part of a decade I have made interest rate risk mitigation a hobby. Who knew a career in economics and investments would involve huddling around a microscope focusing on the merits of cash equivalent investments yielding practically nothing. I remember “basis points” being rounded off to give quotes on CD rates like 4 or 5%, and now all you get is a few basis points. So, here we stand looking down the barrel of a yield curve that is so flat you can barely tell which end is which. Investors are piled on top of each-other gripping the absolute shortest term bonds as possible…with good reason. News Flash! Rates ARE going up. but apparently not now. Interest rates across the board are at 13 month lows. Sure, the 10 year treasury is at about 2.5% which is higher than the March 2013 low of 1.55%, but remember we nudged 3% last fall. So, with the Fed about done with the four year $90 billion dollar per month shopping spree, how in the world are interest rates falling? It just doesn’t seem possible right? If the Fed, the biggest buyer in the market, stops buying you’d think prices would come down on bonds, and interest rates, which move in the opposite of price, would go up. That would be correct IF the Fed was the biggest buyer in the market. Last June, in an article I wrote to our clients, I cautioned that this whole bond buying and interest rate drama was going to take longer than people thought. I wrote, “It’s going to take a long time for the Fed to sneak the elephant out of the room since it’s a historically large elephant.” What I didn’t say was that the elephant had friends.
Contrary to the talking heads on the cable financial networks, the financial markets extend beyond New York and problems thousands of miles away are important. The market catastrophe circa 2008/2009 was pervasive. The credit market earthquake in the United States sent an economic tidal wave across the pond that pummeled Europe. In the heat of the moment our central bank backed by both presidents (Bush & Obama) printed and poured cash into the streets like fire retardant. We bailed out everybody, even people that didn’t need bailing out. Love it or hate it, right or wrong, Uncle Sam was fast and decisive. The Eurocrats on the other hand realized that when they formed the European Union a several decades ago, they failed to empower the European Central Bank. There was no entity equivalent to the Federal Reserve in the United States that could act unilaterally to address a financial crisis. Every single move had to be voted on by each of the 18 European Central Bank members. Germany, the strongest economy in the union, was not super thrilled about bailing out the entire beach-going population of Greece, and the Italians collectively realized that money (unlike Ferraris) doesn’t grow on trees. Now Italians are trying to sell us Fiats, which is like they’re doing a bake sale to raise money to fly to the moon. The reality is, countries like Italy, Spain, and Greece have been in default more often than not over the last 100 years.
Fast forward five years. The leaders of the European Union have broken the huddle and they have a plan. They’re going to make interest rates really low. Seriously? That’s so last decade! Why did it take so long to figure that out? Not only are they lowering the Euro equivalent of the Fed funds rate, they are charging on deposits. That, my friends, is a negative interest rate. The president of the European Central Bank, Mario Draghi said he had another move up his sleeve. President Draghi, said they are likely to start a bond buying program similar to that done over the last 5 years in the United States. What does that mean? Interest rates in Europe are dropping to levels not seen since before Napoleon Bonaparte. Seriously.
There is a massive global appetite for safe bonds. Many pension funds, endowments, and sovereign funds must keep a certain percentage in the safest investments. 
It does not take too long to figure out from the table that the United States Treasury is not only the best deal in town; globally speaking it is actually a bargain. What investor wants to spend the next ten years with an economic drama queen like Italy at 2.64% when the “Stars and Stripes” will pay you 2.55%? So there you have it. What ever the Federal Reserve is leaving on the shelves as it exits the global super market of bonds the hoards of bargain shoppers are lining up with bags of money to buy whatever they can. So, get comfortable with low rates because Europe is just getting started.
