Commentary: Rising interest rates and the gathering storm
By Brett Arends
Are investors high?
Stock market investors continue to ignore one of the biggest, fastest jumps in long-term interest rates on record.
Yes, the Dow slipped below 15,000 this week, but it remains near its
long-term peak — despite the harrowing plunge in the bond market in the
past couple of months, which has sent rates surging.
The Federal Reserve's July policy minutes sent markets on a ride
Wednesday afternoon. Steve Russolillo joins The News Hub with a look at
the market's confused reaction as it hedges when the central bank will
begin tapering. Photo: AP
Indeed, I suspect one reason the stock market has risen is that some
naive investors have calculated that they can be safe by “rotating” out
of bonds and into stocks.
Ahem.
I sat down this week with one of the most experienced bond market gurus I
know. When I asked him for his advice, he first suggested — only half
jokingly — “panic.”
His second bit of advice? Keep calm and carry on. His wife just bought
him a large “Keep Calm and Carry On” poster and had it framed. He’s
going to take it into his office and hang it “where all the traders on
our bond desk can see it.” We are, he believes, in an era of rising
interest rates, and they’ll continue to rise much further than most
people realize.
He concedes that that’s only his guess, of course.
But here’s what we do know.
At the start of May, the U.S. government could borrow money for 10 years
at 1.6% interest. Today, barely four months later, it has to pay 2.88%.
At the start of May, someone buying a new home with a $200,000 mortgage
was locking in monthly interest costs of $566. Today, thanks to the
surge in mortgage rates, someone making the exact same purchase will
have to pay $766 a month in interest.
A company with a BAA credit rating has seen its bond rates spike from 3%
to 4% over the same period, and a riskier company with a BA rating
jumped from 3.9% to 5.2%.
It’s easy to be fooled by the low absolute level of interest rates into
thinking these are small moves. Rates are “only” up by 1% or 1.5%, after
all. But actually these are huge moves, because they come from a low
base. Mortgage costs are up about a third in a short period, from 3.4%
to more than 4.4%. Uncle Sam’s cost of 10-year money has rocketed by
80%.
Traders continue to focus on the minutiae of Federal Reserve minutes and
the timing of the Fed’s likely moves in the bond market. Ordinary
investors should focus on the bigger picture. The Fed has announced that
the era of quantitative easing, and aggressive manipulation of
long-term interest rates, is coming to an end. We are due to move,
sooner or later, back to an era of “normal” interest rates. Typically,
that would mean 10-year Treasury rates about two percentage points above
expected inflation, meaning today’s 2.88% yield would become more like
4.5%.
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