Can Japanese Rates Happen Here?

First, chain-weighted or real year-over-year growth in GDP since the start of 2002 has never been negative. It ranged from a low of 1.2% in the first quarter of 2002 to a high of 5.0% in the first quarter of 2004. The most recent reading was 4.8% year-over-year real growth.

Second, mortgage refinancing has been decreasing as a percentage of the stock of existing mortgages over this time. Each wave of refinancing removes those mortgages from the potential refinancing pool until the next major downturn in yields arrives.

The increasing volatility of inflation-protected yields is not consistent with the theory that the bond rally of 2004 has been fueled by the risk-averse. Each basis point on a bond is worth more at a lower yield, and it requires exponentially more "energy" to drive yields lower from these levels than to drive them higher. Bonds are now a riskier investment than they were at the start of the year.

The Japanese Parallel

Twice before in this space I have drawn parallels between Japanese and U.S. interest rates after the two countries' respective stock market peaks in December 1989 and March 2000. The parallels for both six-month eurodollars and euroyen and for 10-year notes continue on the parallel paths first noted here in October 2002 and again in March 2004.

We can see some differences. In the six-month chart, the Fed's decision to cut rates rapidly and significantly after the stock bubble burst is readily visible, as is its recent decision to start raising rates. The U.S. six-month rate is now where the Japanese rates were on an indexed basis at a similar postbubble point in time.

The 10-year chart is more interesting. U.S. rates fell more rapidly than Japan's did, but over the past year, our rates paralleled their experience, short-term reversals included. Our indexed rates are now below where Japan's rates were at a similar point in time.

Ten Years After

Source: Bloomberg

A Tale of Two Rates

Source: Bloomberg