When the market for federal debt instruments perceives no looming inflation problem, long term interest rates tend to move sideways or downwards. When the Federal Reserve Board perceives rising inflation, it tends to increase its short term target interest rate.
Quiz question of the quarter (Q2-2005): Who’s right, the market or the Fed?
Brian Wesbury, one of my favorite economists, does see inflationary pressure these days; he and the Fed appear to agree on that point. But the American, Chinese, and Japanese savers (among others)—i.e., those who choose to help us fund our deficit and roll over our existing debt each week by participating as buyers in the Treasury auction—are bidding long term interest rates down. In other words, those market-makers aren’t seeing the same inflation problem that others are seeing. Either that, or the safe-haven-attraction of the USA's debt instruments is more than offsetting whatever inflation worries they do have.
This is a curious situation. Alan Greenspan agrees:
In congressional testimony earlier this year, Fed Chairman Alan Greenspan described the unanticipated decline in long-term rates as "a conundrum." In a speech delivered Monday via satellite to the International Monetary Conference in Beijing, Mr. Greenspan observed that the development "is clearly without recent precedent."
I’m not in the business of forecasting interest rates (...I'm better at forecasting GDP), but I am strongly anti-inflation, so I’ll keep this chart updated each week. I’ll post it whenever anything interesting seems to be developing.
UPDATE, June 9: Business Week has more on the Fed's "conundrum" . . .
Greenspan seems increasingly convinced low bond yields may be an enduring phenomenon, driven by a complex of international forces the Fed has yet to fully understand.