As an aftermath of announced timetable by Ben Bernanke for finishing Fed’s purchase of bonds, interest rates long-term tend to have increased while the price of stock have quite cratered down. The Bernanke’s plan tends to be premature, especially where there’s 2% economy with the decreasing inflation and the inflation expectations.
Though, only to get little wonky over story of interest-rate, it is noteworthy that the Treasury notes of ten years have increased around seventy basis points of a year till now. At the moment, they are around 2.50%.
Much of the increase in rate tends to be coming from some jump in the securities that are inflation protected in Treasury, known as the TPS. Now this could be something good, as the increasing interest rates show stronger economy. Trouble is that it is real hard, on balance, to find the strong evidence regarding stronger economy. Rather, as is noted by David Goldman, the economist, investors happen to be bailing out from TIPS as they don’t seem anxious about inflation that is running around 1%.
So the sale of TIPS bonds indeed has raised the interest rates of market. And in turn, that has done much damage to stock market. This will perhaps pinch economy too.
Though this is not where the story ends. The break-even spreads of inflation have narrowed remarkably. That includes ten-year inflation implied by TIPS, and also five-year forward expectations of inflation. They all have dropped around sixty basis points that is about equal to rise in the real rates of interest.
So, one might argue, as warning for Mr Bernanke, that the rising rates tend to be deflationary and not growth event. If Fed is very hasty in having its purchase of bond tapered, and then tapering really is tightening-the interest rates might continue rising for wrong reasons, basically deflation instead of fast economic growth.
There’s no doubt about Fed having to end the purchase of bonds and eventually search for some way to avoid over sized portfolio of bond. In the recent months, Mr Bernanke is commended for producing the low inflation and especially when many predicted wrongly the higher inflation.
According to James Bullard, the head of St. Louis Fed, trend of low-inflation might be something quite good. Also, the tapering of bond-purchase can produce deflationary impulses which can damage economy.
It is also noted alongside the crash in gold price with the decrease in the expectations of inflation.
That is the reason it is thought that Fed need to move very slowly in having the policy shifted in the economy that’s still fragile.