There was almost no notice paid earlier this week to one of the more important anniversaries in the financial world. No balloons, no cakes, no speeches. It's a shame this event -- the first anniversary of the bear market in bonds, which took place Sunday -- has attracted so little attention from anyone other than financial professionals. Because it's an example of how the world really works.
Here's the deal. Interest rates on Treasury bonds have been rising since June 13 of last year, when rates bottomed out at 3.11 percent for the 10-year Treasury bond. Last week's closing rate: 4.80 percent. Yields on five-year and two-year Treasury securities have more than doubled, to 4.06 and 2.81 percent, respectively, from 2.03 and 1.08. Those are pretty hefty increases.
But wait a minute. Federal Reserve Chairman Alan Greenspan has all but said he'll raise interest rates at the Fed's meeting in two weeks. How can rates have been rising for a year when Greenspan hasn't yet raised them? The answer: The Fed doesn't control interest rates. It controls some key short-term rates -- but it doesn't control long-term rates, or interest rates as a whole.
Markets, you see, don't necessarily wait around for the Fed. Rather than leading the circus, Greenspan is chasing after the elephants, trying to avoid false steps as he tries to catch up to the markets.
The impending increase in short rates isn't exactly unanticipated -- the Fed has practically been taking out ads announcing it, and markets have already factored it in. Despite tempting -- for borrowers -- short rates in the 1 percent range, corporations for months have been borrowing more-expensive long-term money in order to lock in rates. Millions of homeowners have wisely opted for fixed-rate, long-term mortgages rather than leaving themselves at the mercy of short rates. Most intelligent borrowers with financial flexibility have locked up as much cheap long-term money as they can, knowing that higher short-term rates are coming.
But there's one big exception. Uncle Sam, who's borrowing vast amounts to cover the biggest federal budget deficit in history, has been shortening the average maturity of his debt, leaving us taxpayers vulnerable to rising short-term rates.
As for locking in long-term rates: Forget about it. Uncle Sam, foolishly, refuses to sell 30-year bonds. The Treasury says that because 30-year rates are higher than 10-year rates, taxpayers are better off taking the risk of selling three sets of 10-year securities rather than 30-year bonds. Well, maybe. Then again, if that turns out to be wrong, the people who made this policy will be long gone.
Uncle Sam could have raised 30-year money a year ago for as little as 4.17 percent, but didn't. Now, it's a better-than-even bet that Uncle Sam will be paying more for short-term money by the end of 2005 than 30-year money would have cost last June. As a taxpayer, I'm displeased -- to say the least.
The Treasury, as you might expect, doesn't see things my way. "We are not market timers," says Brian Roseboro, who as undersecretary for domestic finance makes sure the Treasury has enough cash to keep federal checks from bouncing. "We borrow only what we need. We don't hoard cash."
The reason, Roseboro says, is that, "The interest rate we earn on excess cash is lower than the interest rate we pay to borrow it. That is not effective cash management, which is one of our constraints." Of course, given the way Uncle Sam runs through cash -- the deficit runs $40 billion a month -- it's unlikely that the government's "negative carry" on borrowings in excess of its immediate needs would amount to much.
No one, including me, wants the government to stockpile hundreds of billions in long-term borrowings -- even if it could do so without running up rates. I just think it would be nice for Uncle Sam to act less like a government and more like the astute financial types who advise the Treasury on how to manage its borrowings.
And call me paranoid, but I worry about the combination of the government's increasing dependence on short-term markets and foreign investors to fund the federal deficit. Roseboro says the Treasury "is comfortable with the level of foreign holdings" and sees "no evidence that we face any significant roll[over] risk."
Okay. But if problems arise because foreigners scale back their purchases sharply for political reasons or because they get tired of financing our endless budget and trade deficits, remember that you heard it here first.
Meanwhile, let's see how quickly the Fed raises rates and how long it takes to catch up with the financial markets. Sunday's anniversary is a reminder that the Fed doesn't control interest rates. No matter how many speeches Greenspan makes or in which hand he carries his attache case, the markets rule. The Fed doesn't.
Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org.