Are Interest Rates About to Drop?

Submitted by Rich Toscano on January 6, 2006 - 8:03pm

PIMCO's Bill Gross has written an interesting, if somewhat dense, piece in which he opines that both short- and long-term bond yields are close to topping out. In (very) brief, his thinking is that the lagged effect of rate increases to date will soon start to cause the type of economic slowdown that has historically preceeded lower bond yields.

I find it troubling to question the wisdom of the world's biggest bond investor, and more troubling still to maintain that "this time is different." That said, it seems to me that Mr. Gross' analysis does not fully account for the fact that U.S. interest rates (at least on the long end) are largely controlled by foreign investors. This dynamic—or, at very least, the magnitude of its effect—truly is a new development. Foreign investors in U.S. debt, most especially central banks, have a different set of priorities than Treasury buyers of yore, and it's not clear to me that a U.S. economic slowdown will induce a decline in long rates this time around. Foreigners may find reason to sell U.S. bonds regardless of the state of our economy.

As a matter of fact, an alert Econo-Almanac Forum participant just today posted a link to a Financial Times article regarding China's diversification out of the dollar. China is likely to act very slowly on this sort of impulse, but the point remains that China is moving to diversify out of U.S. bonds. If the foreign central banks ever start selling our bonds in earnest, rates will go up regardless of what's happening with our economy. And this is a risk factor I believe is missing from Mr. Gross' analysis.

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Submitted by sjk on January 6, 2006 - 9:48pm.

Bill Gross is only talking his book....nothing new, or deep, from him.

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