When Will Interest Rates Head Up?
The Fed is keeping yields artificially low and shows no signs of changing course.
The question on just about every bond investor's mind is simply this: When will interest rates rise? With rates on most types of debt near record lows, it seems that rates have nowhere to go but up. That would send bond prices down. And with yields at such depressed levels, the amount that investors stand to lose from a jump in rates has grown (the lower a bond's yield falls, the more it will lose in price from a rise in rates).
The Federal Reserve, under chairman Ben Bernanke, is holding rates down two ways. It is keeping short-term rates near zero by targeting the federal funds rate, the rate at which banks lend money to one another overnight. And it is holding down long-term rates through monthly purchases of $85 billion worth of Treasuries and mortgage-backed securities. The Fed's actions have driven investors to look further afield for income, which has in turn pushed down rates on everything from junk bonds to municipal bonds.
It's impossible to say where rates would be now in the absence of Fed manipulation. Over the past 50 years, the benchmark ten-year Treasury bond has yielded an average of 2.5 percentage points more than the inflation rate. Interest rates on Treasury inflation-protected securities show that investors expect consumer prices to rise an average of 2.5% a year over the next decade, suggesting that the ten-year Treasury, which yielded 1.7% in early April, should yield about 5%.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Thankfully, rates won't be rising to 5% tomorrow (or this year, or likely even next year). The Fed has consistently signaled that it plans not to raise rates until the economy improves significantly. Bernanke recently reaffirmed that the central bank won’t increase short-term rates before the jobless rate drops to 6.5% (it is currently 7.7%) or inflation expectations rise to greater than 2.5%.
And although Bernanke has said the Fed will stop its long-term bond purchases before it raises short-term rates (which could cause long-term yields to rise even as short-term rates stay put), the end of its bond-buying spree could still be years away. In a late-March press conference, Bernanke noted that the Fed's bond purchases seem to be helping the economy and have done so without creating any major risks so far. Moreover, the Fed has signaled that it will vary or taper its purchases before it ends them outright. All of this suggests that the Fed isn't seriously considering allowing long-term rates to rise yet, and that any rise may be slow in coming. (Kiplinger's expects the yield on ten-year Treasuries to tick up to 2.25% by the end of 2013.)
Timing will be tricky. Investors hoping to bail out of bonds before interest rates start rising in earnest will have a difficult task in getting their timing right because of the slow-moving nature of the economic improvement that the Fed awaits. “Most of the factors that drive U.S. interest rates are long in nature and slow in coming,” says Guy LeBas, chief fixed-income strategist for brokerage firm Janney Montgomery Scott. Your best approach may simply be to watch the Fed itself for signs that it is winding down its bond-buying program.
[EMBED TYPE=POLL ID=22730]
Eventually, rising rates will drive losses -- albeit not catastrophic losses -- for many bond funds. (If you hold individual bonds until maturity, you'll get back your principal, assuming the issuer doesn't fail.) But eventually could prove a long time to wait in safe short-term investments that yield nothing. If you want more income today, you'll have to assume the risks that accompany the kinds of investments we describe in this month's cover story.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
-
Is a Phased Retirement Right for You?
Want to keep working, just not as hard? A phased retirement may just be the answer.
By Kimberly Lankford Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
How Inflation, Deflation and Other 'Flations' Impact Your Stock Portfolio
There are five different types of "flations" that not only impact the economy, but also your investment returns. Here's how to adjust your portfolio for each one.
By Kim Clark Published
-
A Spotlight on the Pacific States: The Kiplinger Letter
The Kiplinger Letter Most Pacific states are seeing good job growth in multiple sectors including tourism, hospitality, and construction.
By David Payne Published
-
The Robots Are Coming... But Not For a While
The Kiplinger Letter There’s excitement in the tech sector over the potential of humanoid robots, but widespread adoption is likely to be years away.
By John Miley Published
-
Farmers Face Another Tough Year As Costs Continue to Climb: The Kiplinger Letter
The Kiplinger Letter Farm income is expected to decline for a second year, while costs continue to up-end farm profitability.
By Matthew Housiaux Published
-
Kiplinger's Economic Calendar for This Week (April 22-26)
Check out our economic calendar for this week, as well as our previews and recaps of the more noteworthy reports.
By Karee Venema Last updated
-
A Spotlight on the Mountain States: The Kiplinger Letter
The Kiplinger Letter Most Mountain states are seeing good job growth in multiple sectors from healthcare, energy, and semiconductor production to farming and government.
By David Payne Last updated
-
Why I Still Won't Buy Gold: Glassman
One reason I won't buy gold is because while stocks rise briskly over time – not every month or year, but certainly every decade – gold does not.
By James K. Glassman Published
-
Should You Use a 25x4 Portfolio Allocation?
The 25x4 portfolio is supposed to be the new 60/40. Should you bite?
By Nellie S. Huang Published