americas-interest-rate-conundrum-explained

America's interest rate conundrum explained

The author of bestselling book, The Dollar Crisis explains why the long end of the US yield curve previously failed to respond to Fed rate hikes; but why the long end should now rise.

By Richard Duncan

August 06, 2006

When the Federal Reserve began increasing the Federal Funds Rate in June 2004, the yield on 10-year Treasuries fell instead of rising. Indeed, yields remained below their mid-2004 level until April 2006, despite 15 rate hikes see Figure 1. Chairman Greenspan described that unexpected outcome as a ôconundrumö. In retrospect, it is now clear that the conundrum originated with the discovery of accounting irregularities at Freddie Mac and Fannie Mae.

During 2004 and 2005, when their accounting irregularities came to light, those two agencies were forced to de-leverage to meet new capital requirements imposed on them by their regulators. For example, Fannie MaeÆs balance sheet contracted by nearly $190 billion in 2005. Figure 2 shows...

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