Understanding Why Rates Must Go Lower Leads To Better Risk-Adjusted Results

Is there any conceivable path for Japan – the world’s 3rd largest economy – to escape eventual default? The country owes one quadrillion yen ($8.4 trillion U.S. dollars), yet takes in only $460 billion annually. Even at negligible rates, the Japanese government must allocate approximately 40% of its total tax revenue on paying the interest – just the interest – on its government bonds. Is it any wonder that the Bank of Japan (BOJ) has never been able or willing to raise overnight lending rates beyond 0.5% for 15 years?

The only trick for a nation that cannot pragmatically reduce the size of its sovereign debt is to make certain that the rate it pays on interest payments moves lower and lower over time. The United States is no different. That is why it has been so easy for me to contradict prevailing wisdom on the direction of the 10-year U.S. Treasury Note for more than 16 months. Indeed, every prominent economist surveyed by Bloomberg at the start of 2014 predicted that the 10-year treasury yield would rise from 3.01%. The average forecast? 3.41%. In contrast, I explained that it would have to fall in order to service the interest on the $17-$18 trillion national debt without adversely impacting government services. Ultimately, the 10-year dropped from the 3.0% level to the 2.25% level.

This is the reality for severely indebted countries. I have been making the same case for intermediate-term borrowing costs moving lower, not higher, throughout 2015 as well. Again, the experts universally anticipated the 10-year moving up from 2.25% to 2.75% by year-end. So far, the 10-year has moved lower towards my year-end target of 1.5%.


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A non-profit organization (nationalpriorities.org) recently revealed where American tax dollars went in 2014. A staggering 15 cents on every greenback goes to interest payments on federal debt. If the U.S. intends to honor other obligations such as Social Security, unemployment, the public defense via the military, Medicare as well as universal health care, the percentage allocated to interest on treasuries cannot move appreciably higher. In fact, with the increasing number of boomers reaching the age of retirement and living so much longer, the allocation to servicing debt would actually need to move lower. The only way to do it? Make certain that borrowing costs keep sinking.

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ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser ...

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