Tuesday, March 2, 2021

Interest Rates and Inflation

Last week the various stock market indices did some back flips, apparently because, like a vegan pizza, investors didn't much like the taste of interest rates. Of course the actual rate on that day went up so little that you couldn't find it among the spilled popcorn crumbs left over after my TV watching. 

So I decided to look at a little recent history. Below you will see a graph of the monthly inflation rate (annualized monthly changes of the consumer price index) and the monthly rate on 10 year Treasuries. Inflation is the crazy jagged line. The interest rate looks a bit calmer, perhaps on Prozac, in contrast. 

Getting away from the colorful TV messages and one-day fluctuations offers a nice calm way to think about what is going on out there. More specifically, do recent changes in inflation and/or interest rates offer some message, any message, about what might be around the corner? 

Looking way to the right on the diagram -- in the yellow inflation zone -- you see some crazy gyrations in the monthly inflation rate. Early in the recession you get a deep spike downward that reverses itself. The final points in the graph are more instructive. Notice how the latest inflation information falls between the two lines -- thus it is averaging around 2.5%. I am purposely not reporting the figures with all those decimal points to instead focus on general directions. 

If a monthly inflation rate has a lot of folks hot and bothered, start looking to the left on the chart. How does 2.5% compare to past time periods? Clearly, you can see a lot of data points that landed higher than 2.5% -- and many that were even a lot higher than the 5% line. So whatever might be going on now is nothing like we have seen many times in the last 20 years. If you think it is fun to count data points -- just go back a couple of years -- say 20 points -- how many of those were above 2.5%? 

The other line on the chart is a very popular version of interest rates. The 10 Year Treasury rate is the Tom Cruise of interest rates. It looks kind of sleepy but if you look closely you can see that it was pretty high on the left of the chart and then gradually came down until it hit a new low in the last recession. Notice, like a banana on its back, it seems to be trying to slope up. But come on, folks. There is not a lot there to convince us that we are headed to interest rate hell.

Yes, of course, inflation and interest rates ought to rise from the recent floor. But if the US economy could have long time intervals between recessions wherein the inflation rate often exceeded 2.5% why are we acting so crazy about a one-day interest rate peak of 1.5%? 





1 comment:

  1. I doubt the big banks would accept decreases since they have spent so much (overhead) marketing money and closings promoting the current rates. I would assume their internal profit is somewhat dependent on keeping the rates around where they are. Any lower would create a disturbance in the FORCE. Being just a finance jockey and just looking at the "for real" housing boom in the warmer less crowded and stressed out working areas, plus working at home leaving many of these business, including my son's LPL empty. This means increased demand to funds to support new homes and also to do something with empty office buildings.

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