Recent Significant Global Economic Events – Week 6

Why Our 10-Year Treasury is at 2%:

Back in January of this year, if anyone would have said that at the end of June, 10-year Treasuries would be trading at just slightly above 2% per annum, that speaker would probably have been laughed out of the room. No one foresaw it.

However, as we have come through the spring, two important trends happened:

  1. The European economy continued to slow, not only because of trade wars, but because of other factors. Their GDP growth is currently at a rate of less than 1% per annum.
  2. European banks are amazingly weak even though they are using negative interest rates (that means that a customer putting $1M into a European bank, a year later would only get back $997,000 because the bank charges the customer to put their money in the bank).

European money managers can increase the yield on their cash simply by taking their money out of a European bank account, with a negative interest rate and putting it into a 10-year treasury at a positive 2%.

It is critical to understand that this shift of money from Europe into the US treasuries, while it is benefiting our economy, is being funded by “hot” money. Hot money has no loyalty, it just simply moves wherever it can get the best return. So it may be moving into 10-year treasuries this summer but by fall it could be moving someplace else causing our interest rates to rise.

In the meantime, the bond market is doing the Federal Reserve’s job of reducing the rate of interest on loans. If The Fed reduces its Federal Funds rate that will diminish the impact of the hot money movement because The Fed does not move as fast as the hot money will. The result is the same whether the interest rates are lowered by hot money moving into treasuries or The Fed reducing interest rates. It is the durability of the resulting economic trend that is different.

Lower interest rates enhance new home sales, which is a major leading indicator of the economy. The ripple effects of the new housing industry impacts almost 30% of the American economy.