Interest rates foretell problematic economy

[wp_lightbox_prettyPhoto_image link=”http://www.economicsignature.com/wp-content/uploads/2018/02/20180217-10vs30-year-rate.png” description=”Before October 2017, the rates of the two bonds have a difference of about 0.50%. A quick analysis shows that since October 25, 2017 the difference has started to narrow. The rate difference gradually shrinks to about 0.25%. The narrowed rate difference will induce problems. For instance, banks make gains based on the rate difference, but they will make less profits. For example, a company issuing bonds may prefer a term longer than its reasonable term, but the company may perform badly (or even go bankruptcy) in the long run so the holders of the longer-term bonds in reality bear a much higher default risk.” source=”http://www.economicsignature.com/wp-content/uploads/2018/02/20180217-10vs30-year-rate.png” title=”Interest rates foretell problematic economy”]

 

Interest rates are fundamental of economic and financial analyses. Shorter-term bonds usually have interest rates lower than the rates of longer-term bonds. Ideally, the rate difference should maintain a constant.

Let’s look at the 10-year and-30 year US treasury bonds, whose interests rates are shown above. Before October 2017, the rates of the two bonds have a difference of about 0.50%. A quick analysis shows that since October 25, 2017 the difference has started to narrow. The rate difference gradually shrinks to about 0.25%.

The narrowed rate difference will induce problems. For instance, banks make gains based on the rate difference, but they will make less profits. For example, a company issuing bonds may prefer a term longer than its reasonable term, but the company may perform badly (or even go bankruptcy) in the long run so the holders of the longer-term bonds in reality bear a much higher default risk.

Overall, the rate difference foretells something wrong!

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