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09 28 2015 | by Victor Xing | Central Banks

Why are long-term interest rates harder to control compared to short-term interest rates by a monetary authority?

Long-term interest rates are influenced by a number of factors in addition to expectations of a central bank’s short-term interest rate path (the expected timing and pace of interest rate cut / hikes).

Many of these factors were outside of central banks’ control until the introduction of quantitative easing, which allowed central banks to better influence long-term interest rates by buying bonds on the secondary market to push down long-term rates and to create new bank reserves.

Factors affecting long-term interest rates (Using the Federal Reserve and U.S. Treasury market for example)

Since interest rates along the Treasury curve are set by countless transactions, they reflect investor expectations on the following:

  1. Future path of economy
  2. Future path of Federal Reserve policy (but investors would only project FED policy into the near future, which means 2 to 5 year part of the Treasury curve are more sensitive to policy, and 30 year part of the curve are more sensitive to flight-to-quality flows and inflation expectations)
  3. Major events in other rates markets (such as ECB QE)
  4. Supply events such as Treasury auctions or corporate issuance

The Federal Reserve sets short-term interest rate with the objective of influencing the nation’s credit borrowing cost.  The rate which depository institutions borrow from each other overnight will (overtime) manifest into higher borrowing costs for consumer loans, etc.  This is the standard and preferredmonetary policy transmission channel.

The FED can and did influence long-term rates via QE (or via selling assets held on its balance sheet), but it was much more disruptive to the financial market and economy, and it came with its benefits and costs.

Next article09 27 2015 | by Victor Xing | Capital Markets

Why does Bridgewater all weather strategy need to be implemented with leverage?