On Jan 30, 2013 in a CNBC interview, 2013 Martin Feldstein noted that the Fed’s quantitative easing (QE) program used to increase employment and economic growth has been holding 10-year T-Bill rates very low – then about 1.95%. QE has also made mortgages cheaper than would otherwise be the case. Indeed, new 30-year mortgages have been available at 3.5% for some time. After expected inflation of about 2.5%, the current real T-Bill yield is negative 0.55% and the mortgage real yield is only positive 1.55%. Feldstein noted that when higher employment prompts the Fed to end the QE, then mortgages, T-Bills, and rate-sensitive assets yields will adjust upwards. Feldstein suggested that 10-year T-Bill rates would likely hit 4% to 5% — as seen in in pre-recession 2007.
On the surface the prospect of a 4.5% yield is welcome news to investors looking for higher yields from a rock-solid source. For those already holding low-yield bonds, an adjustment from 2.0% to 4.5% may occur too rapidly to sell low yielding, complex instruments such as mortgages without taking a capital gains hit as market values plummet.
If you bought $10,000 in T-Bills at par yielding 1.95%, and the next day the Fed manipulated rates to revert to a 4.5% yield, the newer 10-year T-Bill would pay $2,965 more than the one you hold. If you tried to sell your T-bill, you would incur a loss near the $2,965 difference in value. Other income sources will adjust in value along with the change in Fed-influenced rates. Illiquid instruments may be worth holding to maturity instead of offering them up at fire sale rates so that you can swap into better-yielding instruments. Of course the Fed would not change yields quite so abruptly and you should check with your financial advisor first.
In a growing, healthy economy, net income for common stock companies will tend to rise making it possible for dividends to increase a small amount. Higher growth will likely create jobs and/or increase wage rates. Social security benefits will rise in-sync with the cost-of-living (or the consumer price index). Pension funds will have a chance to grow their way out of underfunding. On the other hand, the US taxpayers will face even higher monstrous interest payments on the bloated national debt.
Alan Daley is a retired businessman who lives in Florida and who follows public policy issues from a consumer perspective.