Short Term Rates Turn Negative -- Again

I have been discussing the decline in very short-term rates, especially those for the 1-month and 3-month t-bills. As of class today, those rates had fallen to 4 bp for the 1-month t-bill and 2pb for the 3-month, indicating an inversion for the 3-month relative to the 1-month rate. I noted that this may well signal the possibly that something will be occurring shortly, perhaps an upcoming equity market correction (although not necessarily a large correction).

Something did occur later today -- short-term t-bill rates went negative! Here is an article from FT discussing this fact. The article attributes the negative interest rates to a very strong demand by banks to have "pristine" assets on their balance sheets at the end of the year. While I have no doubt this is correct, does this explain the whole story? Consider the explanation above to be a hypothesis, not necessarily "the" fact about negative short-term rates.

My question is whether this appetite for short-term treasury debt is the cause or effect of other things occurring in the financial sector? In other words, the effect of shaky financial fundamentals or upcoming risk could be the year-end appetite for short-term treasuries. This is certainly something to think about. While the appetite for quality assets on bank balance sheets at year end certainly could be expected to put downward pressure on these short-term rates, would it be sufficient to move them all the way to negative values? I'm not so sure.

We'll have to wait to see how this plays out. Let me say, though, that I never expected to see negative short-term rates this soon after the economic free-fall of last fall!

POST SCRIPT: As of the next morning (Friday, 11/20), short-term t-bill rates have returned to positive, with the 1-month at 5.5 bp and the 3-month at 1.5 bp. Note the short-term rate inversion has been sustained. I continue to believe that this rate behavior signals underlying problems with the strength of our financial system that has in part, at least, been picked up by the stock market (recent pull backs). Here is another article written about this in Barrons, the more informative of the two to read.

10-Year Bond Rates

If you look at the 10-year bond rate since the end of 2008, the economic free fall, until the present time, you see several interesting and informative behaviors. First, when the economy was in potentially serious condition in November and December of 2008, rates gapped down on several occasions. This means that bond price gapped up on those occasions. Second, if we apply Fibonacci analysis to the bottom in rates at the end of 2008 up to the present time, you see that Fibonacci has been very predictive for likely declines from the recent 10-year peak of around 4% in June of this year. The chart below shows this (click to enlarge). Remember that the values on the right axis are 10x the interest rate, so 36 is really 3.6.

The 61.8% retracement level (around 3.27%) has been touched on several occasions. Note that the rate has yet to fall to the 50% retracement point (at 3.04%). While we remain slightly above the 61.8 percent mark, note that the RSI is still above the oversold reading of 30, so it is quite possible that we will see another retest of the 61.8 percent level at 3.27%. The likelihood of this rests on, among other things, markets continuing to believe the message delivered by Fed Chair Bernanke the other day.

What we have been witnessing in the short-term, however, is a rising stock market with a strong bond market. So, stock prices have been rising while interest rates have been falling. This is not the typical pattern. Usually stock prices and interest rates move in the same direction. You should think about this to strengthen your understanding of the stock and bond markets. The "other thing" that is not equal is the words of the Fed Chair.

I have recently heard some "talking heads" discuss whether the bond market is a bubble at present, while others are hinting that rates have gotten very high, potentially a cause for worry. I have plotted the 10-year rate weekly over a very long time period. The chart shows this from the early 1990s (click to enlarge). The current 10-year rate is hardly excessive based on its history, which showed it to be around 8 percent in the early 1990s. Note the long-term downward sloping resistance line. Were we to move up to that line, the 10-year rate would have to rise to 4.75 percent, which is approximately the level it attained during the double top in 2006-2007 (note: that double top is what converted me to using technical analysis -- the technical analysis prediction of a declining rate from that double top ran counter to the "traditional economic wisdom" of the day which saw higher rates coming). How likely is it for the 10-year rate to rest resistance at around 4.75 percent? Use the model of interest rates we have developed and enhanced from class:

r = f(expected inflation, autonomous spending components, monetary policy)

Remember: in place of economic growth in this model, you should now employ the Basic Keynesian Model which identifies factors that generate growth: changes in autonomous spending (from C, Ip, G, and NX). The resulting forecast will allow you to move well beyond the limits of technical analysis.