Is Bernanke The Smartest Guy In The Room?

For the last few months, I’ve been short treasuries benefiting from interest rates rising.  During this time, I wrote that the Fed must be really frustrated at the fact that while they (Ben Bernanke) are trying to get rates down, they just keep going up.  Are they frustrated or are they getting exactly what they want?  

The Federal Reserve controls short-term interest rates by essentially setting them. Because of the economic crisis, they have set the rates at basically 0% trying to encourage everyone to borrow more money.  That’s why your money markets and savings are earning next to nothing.  But, long-term rates like mortgages are set by the market.  When a lot of people are selling bonds, interest rates go up.  When lots of people are buying bonds, rates come down.  The Fed can certainly influence long-term rates but they don’t directly control. They can influence them by making various announcements in public.  They can also influence long-term rates by purchasing or selling bonds.

In the past few months, they have not only announced they would be buying billions of dollars of treasuries and mortgage bonds, but they have been doing it.  This initially caused rates to fall but in the last few months rates have been rising even though the economy was weakening.  What gives?  I will argue that treasuries were a bubble and needed to be sold causing rates to rise.  In addition, we know the economy is actually improving now and money is flowing out of treasuries and into other riskier assets like stocks and corporate bonds.  

Mr. Bernanke wants rates as low as possible to encourage us to borrow more.  The more we borrow, the more we spend, and the faster the economy improves.   That’s the goal.  Wasn’t that what partially got us into this mess?  Too much borrowing and too much spending.  That’s another article.  So, Mr. Bernanke should be just down right frustrated with rates approaching 4% on the 10-year treasury bond when they were just 2% a few months ago.  Or is he?

Lately we’ve heard some comments that foreign governments (namely China) are getting a little nervous with holding some much of our debt.  They see us spending.  They see the policies in this country that aren’t pro-business.  They see very low interest rates on their money they are lending.  They see the dollar depreciating. They see rumblings of U.S. debt being downgraded from the almighty AAA/aaa rating.  What if they slow down their buying of our debt?  Rates in this country would go through the roof.  Then how do we get these other countries (especially China) to get more confidence and continue holding our debt and more importantly buy more to keep rates relatively low for the long-term?  Offer them higher rates.

Maybe Mr. Bernanke has rates exactly where he wants them.  Rates are increasing enough to entice those foreign governments to take new money and buy our bonds right now.  Ben Bernanke knows the economy’s improving.  He doesn’t mind rates going higher.  Higher rates means new investors.  On the other hand, rates are low enough to encourage borrowing. Remember, the rates on mortgages are still extremely low. You can still finance a new car for 0%.  They’re historically very low.  So, maybe the Fed is buying bonds but not enough intentionally.  

Maybe Ben Bernanke isn’t as frustrated as we thought but instead is playing the global financial markets like a puppet.  This could be pure genius.

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