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Home Publications Blogs Beat the Press Why Aren't the Prospects of Higher Rates In the United States Leading to Higher Rates In the United States?

Why Aren't the Prospects of Higher Rates In the United States Leading to Higher Rates In the United States?

Friday, 31 January 2014 07:57

The NYT had an article discussing the extent to which political unrest in Thailand might have an impact on its economy. At one point it notes a flight of foreign capital from Thailand and other developing countries which it attributes to the Fed's taper and the "prospect of higher interest rates" in the United States.

The problem with this story is that long-term interest rates have actually been falling in the United States. If investors are fleeing Thailand and other countries because they expect long-term interest rates in the U.S. to rise, then these same investors should be dumping long-term bonds in advance of the interest rate hikes (which would lead to capital losses) thereby causing the rise in interest rates they expect. Instead interest rates on 10-year Treasury bonds have fallen from just over 3.0 percent in late December to under 2.7 percent as of Friday morning.

This suggests an alternative explanation for the flight from developing countries. Most likely it is a simple story of contagion, where investors feel the need to do whatever they see other investors doing. In prior years it was fashionable to unthinkingly put money into developing countries. Now that fashions have shifted the cool thing to do is to pull money out of developing countries. Since investors rarely get in trouble for making the same stupid mistake as everyone else, there is a big incentive to follow fashions in investing.

Comments (9)Add Comment
You mean Advisors and Traders, not Investors
written by Ron Alley, January 31, 2014 7:32
Investors get into trouble when they lose money. It's the Advisors and Traders who do prosper by making the same stupid mistakes as everyone else.
written by dax, January 31, 2014 8:54
Ending tapering is not the same thing as increasing interest rates. It could very well be that what's driving markets in developing countries is the end of tapering and not the specter of increased rates.

So, even though contagion is a partial cause, it's not I think the initial one, which really is the end of tapering.
we are the goon squad and we're coming to town, beep, beep!
written by Squeezed Turnip, January 31, 2014 11:39
Yes, I can see Tyra Bank's next show: Top Investor. Winners get their face plastered on the covers of WSJ and Forbes. They get to be advertising campaign spokesperson for top trading firms and investment banks. Losers get lambasted by the Shark Tank crew.

You mean Advisors and Traders, not Investors
written by Ron Alley, January 31, 2014 8:32
Investors get into trouble when they lose money.

No, they get into trouble when they lose more money than most everybody else. They can lose money and be declared a genius even most especially when they manage to not lose their shirt in a downturn. i think that is Dean's point: it's all relative: you can't get into trouble for being average (because nobody can beat the market).
where does the money go ...
written by Kosta, January 31, 2014 12:38
As dax said, this is most likely about the end of the taper. But a small point. When money leaves emerging markets, where does it go? A lot of it goes into U.S. Treasuries, particularly long-term treasuries, driving up their price and lowering long-term rates. A drop in long-term rates is absolutely consistent with flight from EM.
If interest rates are falling then why is the money leaving emerging markets
written by Dean, January 31, 2014 1:14

it's fine to say that lower Treasury yields are consistent with money leaving EM, but then why is the money leaving? The taper is supposed to be associated with higher rates. It obviously isn't -- at least not now. (Rates did rise in June on the announcement of the taper, but that can't explain a flight from EM in January.)

Sorry, blaming EM troubles on the taper just doesn't make any sense.
written by Kosta, January 31, 2014 3:47

You make a good point about it being unclear why money is leaving EM. I think it's clear that *some* money is leaving EM and going into treasuries, as explained by the drop in EM currencies and the corresponding drop in long-term rates. But why is money leaving in the first place?

A better story might be the expectation of higher growth in the U.S.? In the long term, that would mean higher U.S. rates. But the media certainly isn't playing that angle.
? regarding housing bubbles
written by jim, February 01, 2014 3:10
out of curiosity, it can't be a coincidence that all the countries that seemingly have housing bubbles have set much higher minimum wages than the US i.e. Canada and Australia, can it? even the UK has raised minimum wages quite aggressively for the 21 and over crowd y/y which may explain some of the discrepancy between housing prices being higher in the uk than here.
Taper: What It Means
written by Larry Signor, February 01, 2014 6:21
The Fed has not been reducing market liquidity via the "taper". They have simply reduced the growth in liquidity, hence "taper". This is not likely to be the reason for capital outflows in sketchy economies. It is most likely the potential for increased returns in more stable economies. Contagion sounds right.
written by dax, February 03, 2014 6:50
"Blaming EM troubles on the taper just doesn't make any sense."

QE put liquidity into the market. That liquidity went into many places: the stock market, housing, EMs. That's why the Fed did QE - to increase asset prices - but obviously it didn't have control over which asset prices, so there was a general rise worldwide. Now the liquidity is being reduced. OK the stock is still increasing, but the flow is decreasing, and I thought it was agreed it was the flow which was important (as I recall one of the Fed working papers said so). So money is being pulled from the most illiquid places first, i.e. EMs, under the theory it's always best to be the first to panic when panicking matters.

Contagion as a theory is fine; of course some contagion is involved. But for there to be contagion, there has to be a problem somewhere first. And contagion doesn't explain where that problem was or why it occurred.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.