Quantitative Easing: Interest Rates Head to Zero?

FT.Com -- Financial markets notched up another historic milestone on Wednesday as the yield on 10-year U.S. Treasury debt fell below 3% for the first time in 50 years (since March 1956, see chart above). The decline in yields – to a low of 2.98% – comes in response to unconventional policy measures taken by the US Federal Reserve this week aimed at pushing short-term and long-term interest rates lower. This so-called “quantitative easing” is a strategy central banks use to fight deflation, the dreaded combination of declining growth and falling asset prices.

“It is astonishing that yields are so low,” said Michael Chang, interest rate strategist at Credit Suisse. “The current environment is not like anything we’ve seen before. The Fed’s being very aggressive in quantitative easing, and the fall in yields is the result.”

On Tuesday, the Fed said it would buy $600 billion of mortgage bonds issued or guaranteed by government agencies such as Fannie Mae and Freddie Mac. This pushed mortgage rates sharply lower. The lower rates threaten to trigger a wave of refinancing of mortgages, the prospect of which in turn pushes investors to hedge that risk by buying 10-year Treasury debt, a benchmark for many mortgage rates.

Weak economic data released on Wednesday reinforced the gloomy economic outlook and the potential for declines in growth. The latest wave of data showed collapses in new home sales, consumer spending and orders for durable goods in October. Such evidence of crisis in the US economy will fuel the Fed to try and stem declines in growth by pushing interest rates lower.

MP: See chart below illustrating the "quantitative easing" of expansionary growth of M2 and 3-month T-bill yields going to zero.