Interest Rates – U.S.

U.S. interest rates can be characterized in two main ways, by credit quality and by maturity. Credit quality refers to the level of risk associated with a particular borrower. U.S. Treasury securities, for example, carry the lowest risk. Maturity refers to the time at which the security matures and must be repaid. Treasury securities carry the full spectrum of maturities, from short-term cash management bills, to T-bills (4-weeks, 3-months, and 6-months), T-notes (2-year, 3-year, 5-year and 10-year), and 30-year T-bonds. The most active futures markets are the Treasury note and bond futures traded at the Chicago Board of Trade (CBOT) and the Eurodollar futures traded at the Chicago Mercantile Exchange (CME).

Prices – T-note prices from mid-2009 through early-2010 traded on the defensive in a sideways range due to the U.S. economic recovery that emerged in the second half of 2009. However, T-note prices then rallied starting in April 2010 due to the European debt crisis and the sharp downdraft in stock prices that nearly sent the U.S. economy into a double dip recession. The U.S. economy in Q2-2010 registered growth of only 1.7%.

Federal Reserve Chairman Ben Bernanke during the summer of 2010 became worried that the U.S. economy was stalling and was in danger of slipping into a deflationary trap such as the one seen in Japan for much of the past two decades. As a result, the Fed in August 2010 announced that it would use the incoming cash from principal repayments on its mortgage portfolio to buy Treasury securities, thus preventing its balance sheet asset level from dropping and causing a back-door tightening of monetary policy.

Mr. Bernanke then went further at the Fed’s Jackson Hole conference in late August 2010 and raised the possibility of a new quantitative easing program, dubbed QE2 by the markets. After sending up its trial balloon during September and October, the Fed finally officially announced QE2 on November 3, 2010, saying it would purchase $600 billion worth of Treasury securities from November 2010 through June 2011. The Fed’s two Treasury purchase programs meant that the Treasury was buying a total of about $75 billion in Treasury securities per month from November 2010 through June 2011. Those purchase programs should bring the total asset level on the Fed’s balance sheet to $2.9 billion by June 2011, representing an extra $2 trillion of liquidity above the Fed’s normal asset level of $900 billion.

T-note prices peaked in November 2010 when the Fed announced its QE2 program because it turned out that the QE2 program was successful in improving business and consumer confidence and helping to boost the stock market and the economy. The Fed with QE2 was mainly trying to keep long-term yields down and boost asset prices, thus staving off deflationary fears. After the November peak, T-note prices fell in December 2010 and early 2011 as the U.S. economy strengthened substantially and as the unemployment rate fell to a 2-year low of 8.9% by February 2011. T-note prices also fell due to market concerns that the Fed might not withdraw its emergency liquidity in time to prevent an inflationary outbreak. Inflation in early 2011 started creeping higher with the U.S. CPI in January rising to an 8-month high of +1.6% and the core CPI rising to a 10-month high of +1.0%. As of March 2011, the market consensus was that the Fed would leave its funds rate target range of zero to 0.25% in place through early 2012.

Excerpted from the CRB Commodity Yearbook. For more information on CRB products click here