Recent Significant Global Economic Events – Week 5

The Bond Market’s Impact on Interest Rates:

Capitalism depends upon the signals that interest rates send the borrowers of money. If interest rates are high, borrowers have to look for investments that give them an even higher rate of return in order to justify borrowing money to make the investment. In periods of lower interest rates, an increasing number of investment alternatives look good. With interest rates beginning December 2008 at near 0%, everything looked good.

Because of the Quantitative Easing (QE) done by the central banks around the world, an awful lot of debt has been accumulated as both companies and governments borrowed money at very low interest rates. The negative impact of making those payments has not been felt because the interest rate itself was declining.

As central banks including The Fed attempt to reverse QE with QT (Quantitative Tightening), the cost of servicing the expanded debt will become a serious burden for both companies and governments. It is not the objective of a central bank to create bad loans, so they need to be mindful of the fact that any increases in interest rates will have to be done at a measured rate over a long period of time. Similarly, QT needs to be done over a period of time so the whole financial ecosystem has a chance to adjust to the shifting paradigm.