Interest Rate Jitters

The bond market moving up could be a bad thing or a good thing depending on what side of the fence you sit on.

Rising bond prices mean interest rates are headed higher. That’s bad news for stock investors (no wonder the Dow Jones Industrials lost 200 points in the past two trading days).

Higher bond prices are good for non-stock investors because most fixed income securities yield more as bond prices rise. For example, a six-month U.S. T-bill now pays 4.95%. Why invest in big-cap stocks to maybe make 5% a year when you can get almost 5% guaranteed by the U.S. Government?

When bond prices rise, stocks and the economy get hurt. A standard 30-year mortgage today in the U.S. costs credit worthy homeowners 6.12%. Only six months ago that same mortgage had an interest rate of 5.58%. This cannot be good for the weak U.S. housing market.

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The big news the past couple of days has been the rising yield of the bellwether U.S. 10-year bond. This morning, as I write this column, the yield on this popular bond hit 5.4% — the highest level since August 2006.

As I wrote yesterday, interest rates around the world are rising. There’s now fear in the economic marketplace that, instead of cutting interest rates, the U.S. Fed may actually raise them. Hence, bond yields are rising, stocks are falling.

The U.S. Fed meets on June 28, 2007 to make its next interest rate decision. Most economists are expecting the Fed to stand firm (not change interest rates) at that meeting. I say that after leaving the Fed’s key interest rate unchanged for the past seven meetings, on June 28, 2007, the Fed will actually signal higher rates ahead.