Treasury Market Key to Bank Rates

For the past few weeks the financial markets seem to be getting a bit more disquieting.  Debt market concerns and the lack of economic expansion seem to be weighing heavy in the markets.  This distress has effect of keeping a lid on interest rates.

Poor economic news and skittish markets generally always provide a damper on interest rates.  A slow economy leads to little demand for funds and low levels of inflation and scared markets have a tendency to run towards US Treasuries, driving down their interest rates.  A strengthening economy, on the other hand, generally leads to greater loan demand, higher rates of inflation and higher interest rates.

A significant trend in higher interest rates is often first going to be detected in the largest and most liquid fixed income market, US Treasuries.  If US Treasuries make a significant and protracted move up or down, most all other interest rate sensitive investments will follow suit.  When Treasury rates head higher, bank certificate of deposit rates will follow as will money market accounts and lending rates. 

Technical analysts will look for signs of inflation to start pushing up Treasury rates and interest rates overall.  But, measuring future inflation is a difficult task.  Various measures such as the Consumer Price Index, Producer Price Index and Personal Consumption Expenditures are used to measure inflation rates.  By the time these statistics show an elevated and consistent rate of inflation, interest rates have usually already risen.  Prior to consistent and elevated changes in these indexes, the data is inconsistent and often does not hold a trend that leads to higher or lower interest rates and bank rates.

Evaluating the actions of the Federal Reserve and the Federal Open Market Committee is watched closely by analysts trying to gauge the future direction of interest rates as well.  Fed watching is a very important tool, the Feds report gives clear information on whether the Fed believes that loan demand is increasing and therefore pushing rates higher as well as whether the Federal Reserve Board is showing concern over signs of inflation expansion.  Fed comments on these activities can provide signs on the future course of interest rates.  As far as the Fed Funds rate is concerned, this rate is often a lagging rate.  The Fed sets a target that may increase or decrease the Fed Funds rate, but the rate often follows rate movements already taking place in Treasuries.

A prominent example of how the Fed Funds rate is a lagging rate is in 2004 when the Fed engaged in a prolonged and significant increase in the target for the Fed Funds rate.  The Fed funds rate was at 1.00% from June 2003 to Jun 2004 at which time the Fed ratcheted the rate up .25%.   From January 2004 to April 2004, the one year Treasury rate gyrated from 1.15% to 1.35%.  By the end of April the one year Treasury rate was at 1.55%.  At the end of May the rate hits 1.83%.  It’s not until June 30 that the Fed announces the .25% rate increase for the Fed Funds rate, after a significant rise in Treasury rates had already taken place.  This scenario can be observed on several occasions over the past 20 years.

The lesson: watch Treasury rates for signs of interest rate changes in bank rates, certificate of deposit rates, money market rates, mortgage rates and most all interest rate sensitive financial assets.  Not all interest rate movements take their cue from Treasury rates but it is often the biggest driver of other rates and its liquidity and volume make it a reliable and fast reacting indicator.

Tags: bank rates, certificate of deposit rates, fed funds rate, inflation, interest rates, money market rates, mortgage rates, rates, treasury rates

This entry was posted on Thursday, February 18th, 2010 at 10:49 am and is filed under Money Rates. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.