Interest Rates #primers

Interest rates are the foundation of all asset prices, whether financial assets (like stocks), real assets (like homes), or other valuable things (like a college education). Assets cost money, and interest rates can be thought of as how much this money costs. "Cheap money" basically means the money (the debt) was acquired at a low interest rate. Interest rates are also called yields, which is the return on a bond holding.

The foundational interest rates for all US dollar assets are Treasury yields — the return on US Treasury securities, A.K.A. US government debt. Treasury securities are offered at a variety of different maturity dates, called tenors, and are the only investments considered risk-free so form a basis on which all other investments can be judged. As we've pointed out before when discussing how the reverse repo facility is liquidity-draining, if Treasury bills are offering a yield of 5% per year (like they are now), why invest in anything else that isn't expected to yield more than 5%? The answer is, you wouldn't (nor shouldn't). Therefore, we have an illiquidity spiral caused by higher rates.

The Federal Reserve controls overnight interest rates, while longer-term interest rates (and longer-dated bond yields) are decided almost entirely by the market. A central bank can lower longer-term rates by buying the longer-dated bonds (which the Bank of Japan is doing through its YCC policy: buy JGB10Y's to keep the rate no higher than 0.50%).

Bond prices are inverse to bond yields: a cheaper, illiquid bond will have higher yields. A more valuable bond will have correspondingly lower yields; similarly, a "junk bond" will be of little value but offer high yields. When you hear "Treasury bonds lost record value in 2022", it's talking of bond prices, not yields.

#primers