What’s Behind the Interest Rate Slide?
Last summer, the Federal Reserve’s then-chairman Ben Bernanke suggested that interest rates would probably start rising if unemployment dropped to 8.5 percent and inflation remained in the 2 percent range. At the time, rates bumped up on news that the Fed would start tapering its bond buys, then at $85 billion per month. So naturally, real estate and financial experts have been predicting interest rate increases throughout 2014. Unemployment has fallen to the 6.5 percent threshold, inflation remains low, and markets have held up under the Fed’s continuing tapering.
But instead of rising, interest rates have fallen, surprising many who didn’t think there was any way to go but up. The average 30 -year fixed home mortgage has fallen from 4.54 percent at the end of 2013 to 4.17 percent in May, and commercial property owners have benefited similarly. And Fed chairman Janet Yellen has said rates will stay low until at least six months after tapering is complete, which puts us in the last half of 2015 or later.
Why didn’t rates rise when everyone thought they would? There are several factors at play. Let’s start with the Fed’s role. Yellen emphasized that the economy is still weaker than the low unemployment rate suggests, because millions of people may have simply given up looking for jobs. She also noted that first-quarter GDP and the current housing market have been softer than expected, two good reasons to keep rates low.
And it’s not as if U.S rates are alone in the basement. The 10-year Treasury yield in mid-May was 2.5 percent, compared to a 1.3 percent rate for German government bonds benchmarked to the euro. In both cases, as in other countries, inflation rates are even lower than government bond rates. Investors have not just accepted these low returns, but have driven down 10-year Treasury yields by more than 50 basis points since the start of the year.
So the question is why demand is so high for safe-haven investments with little upside. One big reason may be Russia’s activities in Crimea and Ukraine this year, causing risk-averse investors to drive assets to Treasuries, according to Neil Irwin of New York Times. He quotes a BlackRock strategist as estimating that “geopolitical risk is shaving approximately 0.25 percent off of yields.”
So low inflation, sluggish economic growth and geopolitical upheaval are all factors conspiring to keep interest rates low–for now.