In Which Maria Bartiromo Does What Thomas Sargent Can’t….

I don’t know if you’ve seen this commercial on TV, but I always want to scream out the answer every time it’s on.  It shows Professor Thomas Sargent of NYU sitting in a chair on a stage with a man who says:

Man’s Voice: “Tonight our guest, Thomas Sargent, Nobel Laureate in economics and one of the most cited economists in the world.  Professor Sargent, can you tell us where CD rates will be in two years?

Professor Sargent: “No.”

Woman’s voice: “If he can’t, no one can”.

I’m not so sure that’s true.   When one understands how the monetary system works (see here for a detailed description) you know that long bond rates are just a function of short rates which are a function of the Fed’s expectations for future economic conditions.  So fixed income traders are essentially trying to constantly front-run the Fed’s expectations.  There’s some variance in long rates due to the element of market control, but in an environment like the current one I wouldn’t say there’s much.  (See here for a more complete discussion on this).

The short end of the curve where CD rates are pegged is even easier to predict in this environment.  And it doesn’t take a seasoned fixed income trader to understand this.   Short rates like CD rates essentially ARE the overnight rate.  So I thought it was pretty interesting when I read this on CNBC:

1. What is in store for interest rates in 2013?

BARTIROMO: Interest rates will continue to stay at rock-bottom levels. The Fed has already told us rates will remain at very low levels until 2015. I would expect QE4 to be announced sometime in 2013, which will reinforce this notion.

Of course that’s Maria Bartiromo of CNBC fame.  She knows exactly where CD rates are going to be a year from now.  And given the Fed’s promise to keep rates low through “at least” 2015 I think there’s a very very high probability that this is also a solid two year prediction.  Throw in the fact that Q4 GDP is likely to be under 1% and I’d be willing to bet that CD rates will be roughly the same as they are now when 2015 rolls around.

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://www.stableinvesting.com Ryan Melvey

    What are your thoughts on yield curve inversion?

    Does that simply mean that investors think the Fed is going to be aggressively lowering short rates in the near future, making purchases of long bonds still rational?

  • LVG

    I read that article. I think it’s funny that Cramer doesn’t get it and Bartiromo does.

  • Bond Vigilante

    Both short term and long term rates are determined by “Mr. Market”, NOT the FED. The only thing the FED can do is increase or decrease liquidity and bank reserve requirements. When the FED says that short term interest rates will remain low into 2014,2015, they signal that the economy is going to be VERY weak into that same year.

    BTW: The yield curve (5 year notes vs. 30 year bonds) continues to steepen. Signaling that the economy won’t recover any time soon. Only when this yield curve starts to flatten (like it did in 2004-2006) then an economic recovery is at hand.

  • Nils

    Well the Fed is a participant in this market, and a large one at that, isn’t it? Was there ever a case when the Fed was ineffective at setting rates?

  • Geoff

    Don’t fight the Fed

  • Greg

    “Both short term and long term rates are determined by “Mr. Market”, NOT the FED”

    I will assume you are correct just for the sake of argument. What you are essentially saying then is that we have low rates now because bond traders want low rates. Bond traders are happy with less than 2% returns because they know the weak economy wont support higher rates in the US.

    So tell me then why are they trying to extract even more from Europes even weaker economies? Are bond traders just racist Europhobes who only care about the fragility of the US economy?

    Your statement is a falsehood. Bond traders would love higher US interest rates. They arent benevolent coddlers of the US economy, they are rapacious capitalists. They wont get higher interest rates til the Fed says they will.

  • Johnny Evers

    I don’t think Maria Bartiromo or anybody knows ‘exactly where CD rates are going to be in a year,’ although human nature being what it is we all think we do.
    Lots of things could happen — Europe, fiscal cliff, bond trader panic, recession, recovery, war in the Middle East, stock market crash, black swan, etc., etc.
    Our record of predicting interest rate moves is very poor.
    And the Fed’s record of predicting economic moves is not very good, either.

  • http://thebuttonwoodtree.wordpress.com Romeo Fayette

    That Sargent commercial is for Ally bank’s “raise your rate” CD, which essentially lets your CD rate ratchet up if rates rise. Sounds like a great deal, right? Ally knows that Mom & Pops don’t know how CDs work: a real investor would ask himself what the guy on the other side of the trade (Ally) knows that he himself doesn’t. Point is, Ally understands the system & the Fed’s ZIRP pledge.

    On a side note, most people don’t know that a lot of [brokered] CDs trade on secondary exchanges. Most people get a CD from their bank, who penalizes them for redemption and lock NAV at 100 cents through maturity. It’s interesting how it affects people’s psyche when they learn of brokered CDs with free floating NAV (pricing more like a short term bond). Even though brokered CDs give people more liquidity and even though bank-issued CDs suffer the same loss of purchasing power (inflation) all things being equal, people prefer either/or (both/and) ignorance/helplessness.

  • Bond Vigilante

    Hihger interest rates would lead to lower bond prices. Do you want to hold t-bonds goig down in price ? Higher interest rates would signal that there’s more supply than demand. And then investors/traders would flee the bond market as well. Pushing interest rates even higher.

    That’s what happened in february of 1980. Rates rose so high that traders/investors fled the markets. Then the FED was in panic. Because foreign demand completely disappeared. Back then Paul Volcker raised short term interest rates by 2%, crashing the US economy. Back then the US economy was able to swallow higheer interest rates because the federal debtburden was a “mere” $ 1 trillion.

    Greece has a Current Account Deficit, an net outflow of money. It depends on foreign investors to recycle that money back into Greece (buying new greek T-bonds). Now investors won’t buy greek bonds anymore. More over, wealthy greek persons have taken their money out of Greece and deposited that money in other countries. So, the greek financial system is being starved to death.

  • Bond Vigilante

    1. short term rates will remain low for a long time, as dictated by “Mr. Market”.
    2. I continue to expect that long term rates are going to rise significantly, to say 3 or 4%. Just enough to scare to wits out of the Obama administration.

  • Bond Vigilante

    What about the timeframe 1950 to 1980 when rates went up from about 2% to 15% ? In 1980/1981 the prime rate was even 21%.

  • Johnny Evers

    I would guess that if that happened then the Fed would begin buying T-bonds in enough quantity to drive the rates back down. I don’t think we’re in a position to issue $2 trillion annually in new bonds at 4 percent, not to mention additional bonds maturing and needing to be rolled over.

  • ES71

    So, what do you call this environment with negative real interest rates? Isn’t the end result the same as inflation even though the drivers are different and headline inflation is low.
    To counter it you have to do the same thing you would do in high inflatio environment:
    1. convert to a different currency or durable goods
    2. spend all that remains as soon as you can by buying more durable goods or real estate

    In the end how is that a normal economy when you cannot save anything?

  • Geoff

    Nice photo of Sweet Maria. She’s still got it.

  • http://wpowerproducts.com Max Stanford

    Higher interest rates would lead to lower bond prices.

  • Tradeking13

    That’s why Ally has this “Raise Your Rate CD” program, because they know where rates will be 2 years from now.

  • Bond Vigilante

    The FED has already monetized some 30% of all US T-bonds with a maturity longer than 10 year.

  • New Guy

    I’m interested to hear CR’s response to this…

  • Hoffa

    Thomas Sargent is maybe the main proponent of using utility functions in economics. It was really sad that he received the Nobelprice after the financial crisis. Utility functions is just as much bullshit as rational expectations and EMH. Now a new generation stand ready to learn this nonsense.

  • Anonymous

    It is all about the capital flows…… the problem begins when the capital flows reverse.

  • jaymaster

    That means they still have a 70% buffer!

  • Pierce Inverarity

    You keep bringing this up, but you realize the fed was pushing up the rates at this point to combat inflation, right?

  • Pierce Inverarity

    We also don’t need money from other countries to fund our government. Primary dealers do that.

  • http://make300aday.com Steve Wise

    lol yup.