The Federal Reserve meets periodically to set the rate that banks borrow money in the short-term. This rate has an impact on a lot things, such as mortgage rates and treasury bonds, so its worth watching. Raising rates increases the cost of borrowing and acts as a brake, slowing things like the housing market down. (At least in theory.) Whether that is good or not depends on your investment bets.
After a long time without any increases, the trend this year is (finally) up.
The Fed has raised rates steadily but long-term rates have been slow to follow. Until now.
Long-Term Rates Creep Higher After Years of Resisting the Fed
April 4, 2006
After stubbornly resisting nearly two years of prodding by the Federal Reserve, long-term interest rates are on the rise, a trend that could eventually slow the nation's expansion.
Yesterday, the yield on the 10-year U.S. Treasury note -- the foundation for long-term interest rates -- rose as high as 4.905%, matching a two-year peak set in May 2004. Some analysts believe the yield is on a run that will take it above 5%.
The upturn, spurred by deepening economic growth in the U.S. and abroad, is pushing up the cost of a widening range of consumer and business loans -- including 30-year mortgages and corporate bonds -- from extraordinarily low levels.
The Fed directly controls short-term interest rates, but it has less influence over long-term rates, which depend heavily on other factors, such as expectations about inflation and investor demand for bonds. Until recently, long-term rates have largely ignored the Fed's repeated attempts to push them upward by raising short-term rates. Now, however, with economies and interest rates on the upswing in Japan and Europe, the Fed finally seems to be gaining some traction.
Last week, the Fed increased its short-term interest-rate target to 4.75% from 4.5%. More importantly, it signaled that is likely to raise rates to 5% at its next policy-making meeting May 10. That helped spark a rise in the 10-year note yield to 4.87% in late New York trading yesterday from 4.71% a week earlier and 4.55% at the end of February.
"I think the market is beginning to recognize not only that rates might not be capped at five [percent], but, more important, that they might not be coming down anytime soon," says Keith Anderson, chief investment officer at BlackRock Inc., a money-management firm based in New York.
The rise in long-term rates represents a big change for the Fed. Since June 2004, when they started raising short-term rates, Fed officials have looked on bemused and at times apparently frustrated as their efforts failed to produce a reaction at the longer end of the market. Former Fed Chairman Alan Greenspan described the situation as a conundrum.
The Fed doesnt see the increase in oil costs slowing things down and still worries about inflation.
Fed Raises Rates By ΒΌ Point, Hints More May Come
Bernanke's Debut Statement Shows New Transparency; Stocks Fall, Bond Yields Rise
March 29, 2006
At his first policy meeting as Federal Reserve chairman, Ben Bernanke picked up where predecessor Alan Greenspan left off: with another quarter-point boost in interest rates, and a hint of more to come.
Economists generally said that how much higher rates go depends mostly on whether the risk of inflation becomes reality. Ethan Harris, chief U.S. economist at Lehman Brothers, said, "I think you're going to see both...tightening capacity and some kind of pickup in inflation." He predicted the Fed will eventually lift its key rate to 5.5%.
Larry Kantor, co-head of research at Barclays Capital, said, "The financial environment is still stimulative: high stock prices, relatively low bond yields." He predicted that even if the Fed paused soon it would have to resume raising rates shortly afterward.
All eyes look at consumer spending.
Interest Rates Keep Climbing; For How Long?
Yield on 10-Year Notes Reaches Highest Level in Nearly Two Years; Japan and Your Home Mortgage
March 7, 2006
The yield on the 10-year Treasury note rose to its highest level since June 2004 -- a sign that a renascent global economy could bring higher interest rates on everything from U.S. home loans to corporate bonds around the world.
Strong growth tends to bring higher inflation, which pushes up interest rates.
Some economists and investors believe a movement toward much higher U.S. interest rates could sow the seeds of its own reversal. That is partially because U.S. consumers are heavily indebted. Household mortgage debt rose to more than $8 trillion in 2005, from less than $5 trillion at the end of 2000. Some economists worry if the cost of servicing mortgage debt rises too much, it could slow the economy and bring interest rates down again.
"This debt-laden economy...just can't stand sustained increases in bond yields," said David Rosenberg, chief North American economist at Merrill Lynch in New York. That, he said, is why similar increases in the past few years have always reversed themselves.
