1.) US economic growth and inflation were holding steady at moderate levels.
2.) There was heightened demand among investors for perceived “safe-haven” investments like US Treasuries given the European debt crisis and larger macro uncertainty.
3.) We continued to see buying of US Treasuries by non-price sensitive buyers such as the Bank of Japan, the Central Bank of China and the Federal Reserve.
As we head into 2013, all three of these forces remain in place. Gross domestic product has grown at a moderate rate of 2.5% year-over-year with inflation readings falling inside the Fed’s target range. Investors continue to look to US Treasuries when markets get rocky (and there are still plenty of rocks out there). And central banks around the world are still active buyers of US government debt.
The most recent announcement helps add clarity to investors’ signposts of rising rates. Because the Fed is explicitly targeting an unemployment level with a limit on inflation, investors now have specific indicators to watch to gauge whether rates may head higher.
Another indication that rates might rise? Less demand for Treasuries, either from central banks or other investors. A reduction in purchases by the Fed or other banks could remove significant buyers from the Treasury market, sending prices lower (and rates higher). Also, if we to see a positive resolution to the ongoing fiscal crisis in Europe and cliff in the US, it could spark increased demand for higher risk assets and a sell-off of US Treasuries. But until any of these events happen, talk of rising rates is likely premature.
The bottom line is that as we head into 2013, we are unlikely to see a significant increase in rates, at least in the near term. The factors that kept interest rates low throughout 2012 appear to be very much in place as the clock ticks down to the New Year.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.