With a formal background in economics, I have no problem being a bit self-deprecating by sharing an old joke. It has been said that all the economists can be lined up one by one around the world and they’d never reach a conclusion.
Yes, it’s a terrible pun but it underscores the confusion of investors over what to make of recent interest rate fluctuations. We know that bond prices decline and interest rates rise as the economy strengthens. Alan Greenspan has done a wonderful job of telling us that the economy has been growing nicely exclusive of the now famous “soft patch”. Then why are interest rates falling?
One popular theory is that interest rates rise in order to keep inflation in check. However, with oil hovering at or above $50/barrel and investors hesitant to take big positions ahead of the November elections, many economists believe these counterbalancing effects are keeping inflation subdued. In turn, bond investors are willing to hold/buy bonds which keeps prices high and interest rates low.
On the other hand, the real interest rate (an inflation-adjusted spin on the nominal rate that we read about) is still far below historical and long-term averages which is why The Fed continues to raise rates throughout this “soft patch”.
With The Fed and the markets at odds, the next few months should be very interesting as many of the “what ifs” such as oil prices, the upcoming elections and the year-end tax selling season begin to define themselves.