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Rise in rates, like winter's first snow,
was inevitable
By Greg
McBride, CFA • Bankrate.com
 Has
the recent sharp run-up in bond yields and mortgage rates truly
been a surprise? While the timing is always unpredictable, the events
were inevitable. In fact, the sharp jump in long-term interest rates
since late June is not unlike the first big snowstorm of winter.
No one knows exactly when it will come, or how much snow it will
bring, but it will inevitably come. And when it does arrive, it
also means that winter has begun.
Many shrieked in horror when bond yields and mortgage
rates made their sharpest jump since 1987, forgetting that it comes
from the lowest levels seen since 1957.
When bond yields and mortgage rates plunged to the
lowest levels in more than 45 years, it set off a historic wave
of mortgage refinancing and a deluge of corporate bond issuance.
However, Treasury bond yields were declining on the premise of a
doomsday economic outlook and a hope among front-running bond investors
that the Federal Reserve would employ unconventional methods, such
as buying up long-term Treasuries, to push long-term interest rates
lower and keep deflation at bay.
But then the bond market winds suddenly shifted.
Perhaps some of this is attributable to the Fed's quarter-point,
rather than half-point, interest rate cut on June 25. However, speculation
that the Fed was done cutting short-term interest rates began to
surface just moments after the Fed's June 25 announcement hit the
news wires. Such speculation can lead long-term rates higher as
investors looking into the future begin to account for the likelihood
of higher inflation and the eventual need to raise interest rates.
Had a half-point cut been employed instead, events are likely to
have unfolded in a very similar fashion as investors could be even
more certain that the Fed was done cutting interest rates.
Indeed there were other, more significant factors
triggering the avalanche in bond prices. Strengthening economic fundamentals
-- such as rising durable goods orders, improving conditions in the
manufacturing sector, and stronger-than-expected second quarter corporate
profits -- painted an economic picture that was far different from
the negative outlook that had aided bonds and mortgage rates in recent
months. When Alan Greenspan, in Congressional testimony, began to
back away from the notion of the Fed buying back long-term Treasury
notes, deeming such a move as unlikely, investors buried to their
hips in bonds couldn't shovel their way out fast enough. The forecast
had changed, and bond investors reacted accordingly. As if these changing
currents weren't enough, the glut of Treasury debt issuance required
to fund the ballooning federal deficits helped send bond yields and
mortgage rates skyrocketing.
Even though the inevitable sharp spike in rates has
buried the refinancing rally, mortgage rates remain incredibly attractive
for home buyers. One year ago, the average 30-year fixed rate mortgage
had dropped no lower than 6.34 percent -- and all anyone wanted
to talk about was how great rates were. The average 30-year fixed
rate mortgage in this week's Bankrate.com national survey registered
6.43 percent.
Just as the onset of winter brings about colder
temperatures, the sudden surge in long-term interest rates has ushered
in a trend toward higher rates that will persist as long as the
economy continues strengthening. It won't continue to be dumped
on us all at once, any more than an entire winter's snowfall is
registered in one November weekend, but will instead persist over
many months.
Greg McBride is a financial analyst
for Bankrate.com.
For advice regarding your specific
situation, please e-mail one of Bankrate.com's
Q&A experts or visit the Personal
Finance Advice channel on Bankrate.com.
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