For several years leading up to 2011, investors were assuming that inflation would carry interest rates in the US sky high as our government dealt with the credit crisis. The Fed’s “open spigot” strategy, keeping the money taps flowing, and the administration’s fiscal stimulus – surely all that money sloshing around would create substantial inflation. We were long on the other side of this argument (see Slow and Low, in Resources, for our article in the Portland Business Journal on the topic), believing that inflation wouldn’t translate to high interest rates any time soon.
Now, investors have swung the other way, worrying that the US is in for a long period of slow growth, just like Japan, with potentially permanently low interest rates. But the link between being like Japan growth-wise, and having a bond market like Japan’s is not so clear. Japan’s own citizens buy its bonds and for many, those bonds are the only available investment alternative for income; the US must rely on the largesse of foreigners to fund its debt. Thus, Treasuries compete with many other investment alternatives, which we think will prevent low rates forever. We still don’t think big rate hikes are anywhere on the horizon, but assuming that low growth will always mean a yield under 2% on the ten year Treasury could prove unrealistic.