Sydney Homer

Any person with a desire to understand yields must keep a copy of Sydney Homer's A History of Interest Rates close at hand.

A few observations from Homer: It is apparent that real rates vary widely from decade to decade and from year to year.  Even in the 20th century the ten- year averages vary from +6.01 to -1.78. (chart 50 pg 430) The extreme swings in real rates resulted mainly from extreme swings in inflation (or deflation) rates connected with wars or depressions. Before the 1970's nominal rates were more stable than either inflation or real rates.

The connection of historical fluctuations in real rates with wars and depressions goes far toward explaining why the concept of real rates was largely ignored until recent times. Indeed, there was no mention of the concept in the first 2 editions of this HISTORY or in most academic and financial community discussions.

The change was brought about by expectations. The 70's changed the attitude toward and relative importance of traditional long term bond markets. This ushered in the structural switch in finance to short term and variable rate instruments. LIBOR is the offspring of this historic change in fixed income. The Fed is cornered into a game of holding real rates negative in hope that inflation expectations will alter human action. What they have done, despite the high decibel warnings of the hyper-inflationists, is solidify the fear of a debt depression.

The Street is convinced that the Holiday season will bring with it a new program of long dated bond purchases to replace Operation Twist. Our advice, don't do it- if balance sheet expansion is desired, limit it to 5 years and in.

Leave a Reply

Your email address will not be published. Required fields are marked *