Will World Interest Rates Rise within the next one year?

Dear Friends,

Will World Interest Rates rise within the next one year? I believe so. Why?

Please click on the website link to read the article from UK Financial Times entitled "German Bond Sales Struggles to Hit Target" written on 10 December 2008 by David Oakley.

I quote the most important paragraphs: -

Meyrick Chapman, a fixed income strategist at UBS, said: “When a German bond auction struggles, you know there are problems.

“This is a sign that demand among investors is already waning for government bonds because of the huge supply.”

Other analysts noted the yield was 2.2 per cent, about 4.5 basis points less than existing comparable bonds, which suggests the market is still in reasonable shape because of low interest rates and deflation fears.

Most of the while, Governments are able to manage the money market interest rate. For example, the Federal Reserve had brought its FOMC Interest Rate down to 1% from a high of 5.5% within a period of one year.

However, questions have been circulating in my mind as to whether any Government, including the US Government, can bring down its FOMC Interest Rate to such a low level, and yet, continue to print money, i.e. in the form of issuance of Government Bonds / Treasury Securities.

The German Government's experience as reported in the UK FT article shows that there is a limit to what a Government can do. And I think that the US Government is no exception to the law of the universe, especially in the longer term.

In my opinion, the US Government will have to raise the FOMC interest rate within the next one year, not because it wants to, but out of necessity, if it wants to continue to attract foreign investors from China and Japan, and even the European Union, to its Treasury Securities / Government Bonds.

The issuance of these so called T-Bills are necessary to fund the huge Government Deficits, which are speculated to rise from close to US$450 billion to US$ 1 trillion or more this year, depending on the accounting treatment that the US Government adopts in disclosing its bailout spending.

Once this new trend in interest rate starts, the next important question will be "How High can it go?"

If we learn from the experience of the 1970s Economic Recession experience, which has similarities to the current economic situation, the FOMC Interest Rate shot up to around 7% p.a.. In the early 1980s, the Fed Funds Rate went above 8% p.a.

It should be noted that Oil Price rose from around US$18 per barrel in early 1973 and peaked at US$104.06 (December 2007 term) in December 1979. When it was clear that this high inflationary environment would create an economic recession, the Governments in US and Europe lowered the Central Bank Interest Rates in order to spur the economy.

Sounds familiar? I am talking about the 1970s, and yet, the description fits what is happening today.

What happened subsequently was that eventually, a Hyper-Inflation / Stagflation environment arose, and the Governments of the world had no choice but to increase their Central Banks Interest Rate to 7% p.a.; some even much higher.

What does a Fed Funds Rate of 7% mean? It means that Fixed Deposit Rate will be at least 8% p.a. and the Base / Prime Lending Rate will be at 11% to 12% p.a. This also means that the borrowing rate for corporate loans will rise to 14% to 16% p.a. as there is usually a spread of 3% to 5% which the banks charge, on top of the Base / Prime Lending Rate. There have been situations where banks charge as high as 18% to 22 % in borrowing rate, due to the liquidity squeeze environment.

For people with cash, this is a very happy time. For people who borrow money, this will be one of the toughest times, if not THE toughest time.

In my opinion, the risks of a hike in Central Banks Interest Rate is increasing rapidly, especially so, when we are 1% to 2% from the bottoming of the Central Banks Rate today.

Best wishes,

Ooi