Market interest rates started rising in the middle of 2013. Over the last six months of that year, the economy was strengthening, employment was dropping, and the Federal Reserve began tapering off its purchases of government bonds. The bond market sell-off came as the stock market staged a big rally.
The interest rate on the 10-year Treasury bond hit 3 percent on New Year’s Eve 2013.
But then bond buyers came back, driving bond prices higher and interest rates lower. There were geopolitical tensions in the Middle East and Ukraine, a shrinking federal government budget deficit, and inflation remained worryingly low. Even as the Federal Reserve continued its slow process of removing its stimulus from the economy since then, investor appetite for bonds had remained strong.
That was so in 2014 as it is in 2018. In the week ahead, the benchmark interest rate on the 10-year Treasury bond may break above 3 percent for the first time in four years. This time, it has been driven higher by the same economic worry that has been blamed for the stock market sell-off — inflation.
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Inflation is corrosive for bond investors. It shrinks the purchasing power of the money tied up in IOUs. While last week’s consumer inflation report showed a general rise in prices of 2.1 percent over the past year, it’s the same annual rate of inflation that investors experienced in the middle of 2014 when they bought bonds, sending interest rates down from 3 percent.
But there’s something else this time around: deficits. The new tax law, a two-year budget deal and new proposed spending all add to the red ink from the federal government. This happened just weeks after Uncle Sam posted its biggest annual budget deficit since 2013.
The bond market has been a sleepy place for years. Investors have been eager to lend money to the government at record-low interest rates, encouraged that they will be paid more than what inflation eats away. But now the combination of inflation (though still mild) accompanied by big government spending plans makes this return to 3 percent different.
Tom Hudson hosts ‘The Sunshine Economy’ on WLRN-FM; @HudsonsView.