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.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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