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Why U.S. long-term interest rates have been rising since May 1
Howard Richman, 6/26/2013

On or about May 1, the U.S. long-term interest rate started to rise as indicated by the interest rate on U.S. Treasury Bonds. I follow the movement of long-term U.S. interest rates on the following page:

http://stockcharts.com/h-sc/ui?s=$UST10Y

The graph shows that around May 1, the 10 year U.S.Treasury bond interest rate turned on a dime. It had been going down from about March 11 (about 2.05%) to May 1 (about 1.65%). It has since headed up to about 2.55% today.

I have been trying to figure out the cause. There are several possibilities that could cause the U.S. Treasury bond rate to rise, including:

  1. Prosperity causes an increase in borrowing causing interest rates to rise. But there is no evident prosperity in the U.S. GDP data. In fact, U.S. economic growth seems to be stagnant in the 1.5% to 2% range.
  2. Growing inflation or inflationary fears cause nominal rates to rise. But the inflation rate in the United States was just 1.4% for the 12 months ending in May, according to the Consumer Price Index.
  3. Downgrading of U.S. government debt. But the recent projections show that the U.S. budget deficit this year will be far lower than last year.
  4. The Federal Reserve could be tightening the money supply. There are no Federal Reserve statistics available for the money supply of June or July, but in the three months ending in May, the Federal Reserve was still pedal-to-the-metal with an approximately 9% rate of increase in M1.
  5. Movement of foreign savings out of the United States. This appears to be the only explanation left. But who is taking money out? Not Japan. It's recent policy has been to buy U.S. assets in order to weaken the yuan

According to Lars Christensen, Danske Bank's chief emerging-markets analyst, China's big regional banks have been selling their Treasury Bonds because they are facing a short-term cash crunch. Here's a selection from a Bloomberg article about his explanation (Is China to Blame for Rising U.S. Interest Rates?):

Danske Bank's chief emerging-markets analyst, Lars Christensen, explained the theory to me earlier today. Last week, China's central bank deliberately withdrew liquidity and pushed up the short-term interest rates banks pay to borrow from each other, in an effort to shove the Chinese banking system toward less risk-taking.

That squeeze, Christensen explained, caused Chinese banks to dump Treasuries onto the market. (China's central bank is famous for being the largest foreign holder of Treasuries, but its four largest banks appear to have big stakes, too, according to annual balance-sheet statements.) The influx of sellers then sent Treasury yields up. The U.S. 10-year note now yields 2.6 percent, up 45 basis points since June 1.

Christensen's theory also fits with the fact that the yuan has risen from about $0.159 to about $0.162 since May 1. Chinese caught in the crash crunch could also be selling gold, which could explain why gold has fallen from about $1600 per ounce in mid-April to about $1225 per ounce today.

Chinese economic prosperity does not result in increased prosperity in the United States, due to China's mercantilist policy of continually growing the U.S. -China trade deficit.  But a Chinese financial collapse would give the U.S. some severe short term problems by driving American interest rates up severely and driving the dollar down rapidly.

If China hits a Black Friday 1929 moment soon, the financial collapse could spread worldwide. In 1929 the United States was the world's chief trade surrplus country. It had built up its economy in the expectation that an export boom could continue forever. But, eventually, mercantilists bankrupt the buyers of their products. When they call in their world-wide loans, their boom turns into a world-wide bust.

Mercantilists can solve the worldwide problem by taking down their barriers to imports and boosting the economies of their customers. But the U.S. reaction in 1929 was, instead, to increase the height of its already high trade barriers. It is unlikely that China will be any smarter today.

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