Some Interesting Interest Rate News

A friend of mine alerted me to this.  Billionaire hedge fund manager Seth Klarman says that the actions by the Federal Reserve have taken away the price discovery function of marketplaces.  He’s obviously frustrated since his fund underperformed last year.  Many people will call it sour grapes.

At the same time, I remember the late 1990s.  The market back then had a lot of gas in it, not fueled by the Federal Reserve and other central bankers, but by unbridled optimism over the future of the internet.  In March of 2000, the tech market got its comeuppance.  But, if you were a rational trader the market stayed irrational longer than you could stay solvent.

Today, we are seeing some astronomical valuations for companies that don’t make any money.  Tesla is one example but there are plenty of others.

I learned the hard way in 2009 that you cannot fight the Fed.  With the way things are, and the forward guidance, it’s hard to think that the easy money policy we have seen since 2008 will change anytime soon.  The question becomes, what sort of asset bubbles are being artificially inflated and what will they look like when interest rates change?

Side by side with this, we usher in a new administration.  The new Treasury Secretary, Janet Yellin, used to be Fed chair.  She is an academic.  Academics have different views on markets than people like the prior Treasury Secretary who actually participated in them.  Blackboard theory vs practical knowledge.  Sometimes they don’t jive.  I remember at Chicago Booth a satirical question was, “It works in theory, but will it work in practice?”

One thing Yellin has brought up that is interesting and might help with price discovery in the marketplace that Klarman says is corrupted is her idea of issuing longer-term debt.   For those that were in diapers in the 1990s or before, it used to be that the 30 year bond was the main focus of the yield curve.  Alan Greenspan changed that.  He followed the European model of focusing on the 10-year note and phased out 30-year auctions.

If you are as old as me, you can recall in the 1970s when the 30-year traded at 16% and short term money market rates were at 21%.

Greenspan’s logic was two-fold.

• It is dreadfully hard to predict the future, so having a shorter duration with the ten-year gives you more precise measurement
• Ten-year note debt has to be rolled more often, so it might bring discipline to government spending when they see what their interest rate and rollover costs are.

Neither of those things happened.  I remember when Greenspan announced the policy.  I thought it was the wrong move for American finance but of course, I wasn’t an academic like him.  I was a schmuck short term interest rate trader.

Yellin has proposed a 50-year bond.  I’d go further.  I’d do a 50-year, and a 100-year bond and extend the duration of the yield curve.  We have so much debt right now.  Neither political party takes it seriously.  Don’t tell me Republicans are better on debt because we have proven that they talk a good game but don’t know how to play.  Democrats are even worse.

Remember this, Debt is in fact a tax on all the future earnings of American citizens.  It has to be paid, and our taxes pay it. There is no free lunch. The Fed can’t “create” money without an opportunity cost and that opportunity cost is a tax on your income. 

That’s why the Keynsian economic analysis is always wrong but I digress.

It will be interesting to watch if Yellin pulls the trigger on the 50-year, and if it helps with market transparency and price discovery.

The post Some Interesting Interest Rate News first appeared on Points and Figures.