Why Long Rates Are Falling
Only three times in the last two years has the 30-year Treasury bond moved into the 7.8 percent to 8 percent interest rate "zone." Usually, the bond encounters strong market resistance in moving below 8 percent.</br></br>Why has it been difficult for the long bond to move down through 8 percent, and what will it take for long rates to fall to the low levels of 1987? The answers hinge on inflation and the recovery.</br></br>We have to go back to the first quarter of 1987 to find yields at those low levels, prior to the three recent instances. At that time, the bond traded at 7.27 percent to 7.88 percent, with the lower yields occurring in January 1987. Then, as the economy began to improve and inflation began to rise, rates rose until Oct. 19, 1987, when the Dow Jones industrial average fell 508 points.</br></br>Inflation is the first part of the answer. The consumer price index, a widely followed measure of inflation, rose a mere 1.1 percent from December 1985 to December 1986, helped by a 30.7 percent decline in energy costs. The CPI was up only 3.8 percent the previous year.</br></br>As a result of two good inflation years back to back, interest rates began to trend lower in February 1986, touching briefly at 7.16 percent in July, and then ambulating between 7.16 percent and 7.77 percent before closing the year at 7.33 percent. They plateaued in the first quarter of 1987.