What higher interest rates generally tell us are that there are more loans being created; banks willing to lend at higher rates. This is because they can expect a return from those demanding a loan. Why? Because there is growth. When there is growth and a lot of risk-on sentiment, loaners can make riskier loans because those receiving the loans, albeit even though they might not pay it back, there is a lot of access to liquidity because money is loose. Likewise, banks/loaners are selling off treasuries, because they no longer wish to be in risk-off positions (which, initially drives up rates, and further does so as banks try to jump in on the risk-on fun).
A common misconception is that low interest rates are not only made low by the Fed, but that they are a signal of loose money policy. Well, how can there be loose money when banks are quite clearly risk-off? How is there loose money compared to the mid-to-late 90s Tech Bubble mania? When the entire system, and this is defined by both central and commercial banking, is risk-off, then how can we expect rates to be high? Rates being high is a signal that people want to get rid of their money as fast as possible! In times of low interest rates, the expectation is that the loan-receiver is not able to bring growth.
Those receiving the loan can’t be expected to pay it back = Low growth = Bank Risk-Off = Buying Treasuries = Low Rates
Commercial loans’ interest rates are characterized by the credit spread between they and treasury rates. If treasury rates are low, then commercial loan rates have to in-turn be lower because those rates are being pushed down by banks’ risk-off sentiment.
So for example, the 10-Year (the favorite economic indicator to use) treasury is currently yielding 1.6%. The average mortgage rate today is 3%. That means that taking both risk and return into account, a bank today is willing to garner the 3% yield (plus thousands in fees, don’t forget that) in comparison to a 1.6% guaranteed, risk-free yield from the federal government. The difference between the 10-Year treasury rate and the mortgage rate is what is known as a credit spread. The average credit spread of the two, since 1971, has been 1.69%, so we are right around that average.
The reason for this spread, and why it is important, is because it is how willing banks are to have risk-on vs risk-off return. The reason they don’t just drive up yields on mortgages to whatever they like is because any other bank can just undercut them. How is that possible? Where do they get the money (lol) to do so? I’m glad you asked:
When a bank makes a loan, all that they are doing is increasing the bank deposits of the entity that they are loaning to. They are able to benefit from this loan due to the spread between what they receive on making this loan vs. how much they will have to pay on whatever the overnight lending rate is. One of many ways that they can receive the central bank reserves to back these bank deposits that they have created is by borrowing based on the Fed Funds Rate, which is really just them getting an uncollateralized loan of a very low percentage. Nowadays, with uncertainty built up in the system, this market has become less important compared to the repo market, which is collateralized (where you need treasuries, ABSs, or MBSs as collateral to operate). The current effective Fed Funds Rate, however, is %0.08, so you can imagine that this spread to borrow central bank reserves is a high margin of profit for the bank borrowing.
Nevertheless, this system itself is on the brink of disaster, as it doesn’t quite function how it was supposed to, as banks prefer collateral in doing business, these days, and the process of adjusting reserve requirements seems to be obsolete as Quantitative Easing has become the main tool of the Fed to control the amount of central bank reserve supply (not really money supply). This entails forcibly buying treasuries from banks, and giving them those precious central bank reserves, but the banks are so risk-off and untrustworthy, that this very system has become obsolete as well, as they go back to the Reverse Repo Facility to demand those treasuries back.
And I digress, but in order to scrutinize a system you must be well-versed in its language. That is why, in whatever sequel we have to America and its central bank, we must know what not to do, just as much as we should know what to do.
This is why the spread between junk bonds and treasuries closing in on one another is a sign, to me at least, that treasury rates cannot rise, and will not rally for long. To the inflationists, this is their diamond in the rough. Everything has been disappointing for them because the dollar hasn’t crashed yet, but when they see yields rise, it is a signal that money supply is growing, and treasuries are possibly being sold off, or issued more than they are demanded. If you know about the reverse repo facility situation, you know that it would take persistent trillion dollar bills from the gov’t to make the supply outweigh demand. And harken back, remember - that means money would be loose. Loose money = high rates. In this case, if the system liked that, and banks started loaning out, and businesses were eager to take on loans, and workers were ready to work harder than ever, and inventors were ready to invent like crazy, then yes you could induce a solid decade or two of amazing growth like the Japanese did. This is not a functional, healthy, lustered economy. This is short-term mania followed by a long, drawn-out risk off.
I will repeat: Aggregate demand cannot be artificially increased. This is why socialism does not work, ever. It is completely ineffectual at bring about the demand, and then maintaining whatever tumor it has constructed. The tumor sucks the system’s life away. No better example than the Soviet Union’s massive malinvestment and misallocation of scarce resources with all of the monuments it constructed. Or China’s obsession with builting ghost cities. Or Japan’s obsession with building highways to nowhere, and issuing stimmie checks every time they need to feign central bank relevance. This is socialism at its best. At its worst? Well, you know what that looks like.
Anyway, the fact that junk bond yields are so low is not some signal of safe investments, even in the worst of “high yield” securitized debt! It is simply a sign that debt issuance is uneager, and expectations for high growth are low. This is the outcome of a system that can no longer grow; even the worst investment you can make won’t provide a yield. It is so bad, that there are enough dummies who have made 100x their initial investment on meme stocks and internet tokens. Well, there’s always been enough successful gamblers, it’s just now they are glorified.
To summarize: If banks were eager to lend, they would sell treasuries off, and lend like crazy (relative to now), where rates would be high, but so would liquidity. They could realistically expect a high return, because money velocity would in turn be high; the productivity and expansion of the economy would reflect that people were more interested in spending, than saving, resulting in a lesser necessity for banks to bring down interest rates. In times of tight money, banks have to bring those interest rates down to attract loaning, likewise, they invest heavily in risk-free treasuries, rather than risk-on private securitized debt, so that they can achieve reliable yield. Without banks willing to sell these treasuries off, and risk their hand in the market, the system stays in low-growth. Assume they did, well, there’d have to be an economy robust enough for those interest rates to rise and for them to be eager to issue debt.
“I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”
Thomas Jefferson