Interest Rate

• Interest Rate = Price of Money
• Interest rates measure:
• the supply and demand for credit
• time preferences
• inflation expectations
• confidence in the currency
• expectations for other investors expectations (especially the FED's)

• They are the traffic signals of investment
• They measure time preference
• They calibrate risk
• They set investment hurdle rates
• They have a huge impact on:
• banks
• real estate market
• auto industry
• etc.
• They can fuel or crate prices of other assets like stocks and real esate
• Low rates tend to increase the price of other assess as they become cheaper to finance and reduce discount rates
• High rates tend to decrease the price of other assets as they become expensive to finance and increase discount rates 

• Forecasting interest rates is extremely difficult - there are countless factors
• Some consider it to be impossible
• Central banks often try to forecast interest rates, but are proven incorrect over time

What Determines the Interest Rates

• Short and long term interest rates are driven by different forces
• Long-term rates are usually higher than short-term rates (more uncertainty)
• Rates can be driven by Central bank Actions
• Short term rate adjustments
• Quantitative Easing (asset purchases) to drive long-term rates
• Forward Guidance (Telling the markets what it plans to do)
• Interest rates tend to move in long-term cycles:
• 1900 - 1920 rising interest rates & inflation
• 1920 - 1946 falling rates 
• 1946 - 1981 rising rates
• 1982 - 2016???? (end dates still tbd) falling rates
• Interest Rate Cycles are Natural:  People first consume more than they can produce (rates go up), then later they have to pay it off (rates go down)

What Drives Short-Term Interest Rates

• The supply and demand for credit determines short term interest rates (liquidity effect)
• Short term interest rates are driven by the Federal Funds rate
• The further out the yield curve you go, the less influence the federal funds rate has

What Drives Long-Term Interest Rates

• Long term interest rates are driven by the markets expectations for economic growth and inflation
• Long-Term Treasury Bond Yield = Real Rate + Inflationary Expectations
• See the Fisher Equation
• Dr. Lacy Hunt Model:
• Long-term interest rates are driven by the aggregate demand for money
• Long-term interest rates are driven by the Monetary Base (MB) * the money multiplier (m) * the velocity of money (V)
• The aggregate demand is the same thing as GDP (AD = GDP)
• GDP = M2 * V
• ==> AD = GDP = M2 * V
• M2 = MB * m
• ==> AD = MB * m * V

US Historical Interest Rate Levels (Short Term Fed Rate)

• Rates generally rose in the 1960s and 1970s
• Rates mostly above 2.5% from 1960s to 2010
• Rates mostly above 5% in 1970s and 1980s
• Rates jumped to 10% - 19%+ in late 1970s and early 1980s
• Rates started to decline around 1980 into 2016 (end still TBD as of 2018)
• Rates at historical lows from 2010 onwards (after great recession and FED QE Programs)

• Historically 10 year yields  have traded inline with GDP growth (relationship stopped after 2008 crisis & QE Interventions)