The Down Cycle in Interest Rates -- Part I (Market Rates)

09/23/2007

There are two elements worth considering in forming an assessment of the probable extent and duration of the current down-cycle in market interest rates. The first is an analysis of past short-cycle moves; the second is an assessment of the probable impact of the housing depression on the economy, rates of inflation, and market rates.

Before proceeding with this assessment, we wish to remind our readers that we ARE NOT HERE ADDRESSING THE ISSUE OF THE SECULAR TREND OF MARKET RATES. As we have pointed out earlier, the SECULAR DOWNTREND in market rates is now in its 26th YEAR. 26 years may seem like a long time, but if one places it into the perspective of secular moves over the past century, it is not actually all that long. It would be well to keep in mind that the PRECEDING SECULAR CYCLE OF RISING RATES lasted for 49 years. The yield on long-term Treasury paper was .10% in 1932; it rose from this low until 1981, when long-dated Treasury securities yielded in excess of 15%. While this does not assure that the current DOWN-CYCLE will endure for more years, it is a useful antidote for the endless noise created by financially illiterate literati who are forever proclaiming the end of the period of declining rates.

As a counter -weight to the endless din of speculation and "predictions" from sundry Wall Street gurus, FED "strategists," and their media outlets and amplifiers, who focus on when is the next cut (not too long ago all were focused on "when is the next increase," you may recall), we have reviewed the actual duration of short-cycle market rate moves. Generally, these cycles tend to last 2-3 years, give or take. The current down-cycle began in June 2007, when the yield on the 10-year note peaked in the 5.3% area, culminating in a 4-year uptrend in market rates (with the trough at just over 3% for the 10-year note in July 2003).

Based upon simple arithmetic (no over-hyped, over-sophisticated compute models or statistical analyses for us, thank you very much), we would expect the current down-cycle to last at least until early 2009. Of course, this will not be a straight progression. It never is.

As for the fundamentals affecting the extent and duration of the down-cycle, we will encapsulate our repeatedly expressed assessment -- the bear market in residential real estate in and of itself should suffice to produce a no-growth economy at best for a number of quarters, with inflation tailing off toward the 1% (PCE-core) area, if not lower. A serious deflation in the price of what is essentially the sole asset of most American families, and against which staggering household debt has been wracked up, cannot fail to have MAJOR CONSEQUENCES ON CONSUMER DEMAND, AND HENCE UPON PRICES. In this context, Fed actions are ALMOST IRRELEVANT. Market rates and a very broad range of prices are headed DOWN, DOWN, DOWN.

We will be assessing the probable course of the administered rate (i.e., the FED-controlled overnight rate) and its interaction with market rates and the overall economy in a future analysis.