Price Inflation, Then Interest Rates

While there is no way that anyone can predict the future, and Austrian school economists, of all people, should know this, it does not stop many Austrians from making predictions.  A couple of common predictions amongst Austrians is that we will eventually see higher interest rates and higher consumer prices.  There is certainly disagreement about the timing and about the severity, but there seems to be general agreement that both are likely to go up in the future.

Of course, there are many factors that will affect the overall economy, and in particular interest rates and price inflation.  It matters a great deal on what Fed policy will be going forward.  It matters on what banks decide to do and how much they lend.  It also matters what billions of people in the marketplace decide to do, including their habits of saving and spending.

With that said, I tend to agree with the consensus that interest rates and price inflation are both likely to rise in the somewhat near future (probably less than 5 years, although I hate giving predictions with time frames).  However, I have been against the idea of shorting bonds, which would be betting on higher interest rates.

As I write this, the 10-year yield is near 2%.  While this is really low, it is up a little bit from where it was.  So is this the start of rising interest rates?

I still don't think so and here is my main reason.  The price of gold and the consumer price index are both signaling that imminent price inflation is not a problem.  This could certainly change very quickly at any time, but there just isn't high consumer price inflation right now.  Prices at the grocery store may be going up, but the average prices are probably not going up at double digit rates (on an annual basis).

While I can't predict the Fed's actions with certainty, I can take a pretty good guess.  My guess is that the Fed will continue its money creation in one form or another, as long as price inflation is seen as relatively tame, although there may be short periods where it stops.  And as long as the Fed is buying government debt and mortgage-backed securities while price inflation is low, then interest rates are not likely to rise significantly.

For that reason, I believe that we will not see significantly higher interest rates until we see more signs of price inflation.  This means that we will have to see signs in the way of a higher consumer price index or a significantly higher price in gold (and probably silver too).

Once higher price inflation does become more evident (assuming that happens), then it will be time to take a look at shorting the bond market.  At that point, there are two factors that could drive interest rates higher.  One reason is that the marketplace will demand higher rates to compensate for the threat of inflation.  The other reason is that the Fed may have to scale back or stop its buying of government debt (to save the dollar), thus reducing demand for bonds and causing higher rates.

In conclusion, watch the price of precious metals and watch for changes in the consumer price index.  These are likely to be your best indicator of when you can expect higher interest rates.