|Key Words||Interest Rates, Inflation, Economic Growth|
At every meeting, the Federal Reserve Open Market Committee discusses the future direction of interest rates. Investors, economists and the general public anxiously await the outcome of these meetings. At the Federal Reserve's September meeting, the Fed decided to leave interest rates unchanged and most investors probably heaved a sigh of relief. However, looking at the yield on United States Treasuries since that time, it is obvious that yields have been increasing. This raises the question: if the Fed didn't raise rates, why are rates rising? The answer is that there have been a number of changes in the demand for and supply of financial assets.
One important factor was rising fears of inflation brought about by increased oil and gold prices and economic reports that suggested that the economy had not slowed. The National Association of Purchasing Managers' index - a measure of activity in the nation's industrial sector- had an unexpectedly strong rise in September. The index of prices paid by factories also rose to its highest level in more than four years.
Fears of interest rate hikes cause bondholders to want to sell their bonds. Increased bond selling was also the result of foreign investors dumping U.S. Treasuries because of the increases in the U.S. dollar, especially in relation to the yen. Miniscule interest rates in Japan attracted investors who borrowed funds and used the proceeds to buy U.S. Treasuries. As the yen increased in value, the black ink turned red and caused these bonds to be sold.
Investors also bet on interest rate movements through interest rate swaps, in which one investor agrees to exchange a fixed rate for a floating rate. Interest rate swaps are the basis for 80 percent or more of derivatives held by American banks. As interest rates increase, these derivatives become questionable.
(Updated November 1, 1999)
|Source||Gretchen Morgenson, "Even if the Fed Is Idle, Rates Are on the Rise," The New York Times, October 3, 1999.|
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