Interest rate takeoff promises rough ride

It's almost as sure a bet as the sun coming up tomorrow morning--interest rates will continue to trend up. Given our outsized deficits and egregious national debt, investing in T-bills just gets riskier for buyers who will demand a higher return. And higher interest rates mean servicing our humongous deficits will become even more costly for taxpayers, credit will become more expensive for investors, and the chances for robust recovery will be compromised.

But should we be surprised? Can the Fed sustain rates much longer at levels so far below the historic mean without eventually ramping up inflation. At some point the cheap credit era had to end and unfortunately the crash was just step one. Rates have only been kept artificially low by pumping dollars into the money supply to forestall greater economic catastrophe. As the economy stabilizes we'll need to get off that medicine quickly or inflation infection sets in. And long-term rates have already begun to take off. Welcome to step two--a reversion to the mean.

I'm betting rising interest rates will be the big economic story of the next 18 months. They will slow down any housing rebound and make refinancing even more difficult for borrowers confronting rollovers. And banks may have an even more difficult time dealing with their toxic asset portfolios--delay is not tidying up the picture.

But what should we worry--all those economists are telling us about the second half recovery.   

Comments

[Chris Cummings]

It will be interesting to see how the current administration handles this next potential crisis in waiting. And whether the American Public, who "wanted" this bailout to occur, will keep their heads buried in the sand. (Did you see that John Stossel piece where he interviewed the economists on 20/20 right after the election?)

[Marcelo Bermudez]

Government bond sales have increased to $1.5B, but the rate of issuance for non-government debt has fallen $2B with the net effect of less overall debt coming to the market. That is not indicative of inflation. Historically, the Treasury rates normally rise with no particular reason in May and June and fall back again for the summer. Look at any charts for the last ten years.

The Fed’s H.8 report indicates credit continues to contract. Inflation is not created by the creation of money but an increase in its velocity which isn't happening at this time.

[Tom Gulihur]

Seasonal residential real estate sales peak in the May-July months, which has an intuitive effect on mortgage interest rates, pushing them higher. This mortgage market demand probably leaks back into the T-Bond market.

[Tom Gulihur]

Rising interest rates will definitely be the big story going forward. Residential real estate values have a virtual inverse realationship to interest rates: rates decreasing => increasing buyers' purchase power => increasing buyers interest in buying => increased demand => increase in prices or with concomitant increase in supply, increase in volume of sales... But increasing interest rates will push that chain of events in the wrong direction. When interest rates start to increase the residential real estate market will start to break down. We are "so not even close" to coming out of the woods.

[Neal]

You are correct in that in some point in the future rates will rise. Otherwise you're WAY OFF BASE. The economy is contracting, assets and debt are deflating at an alarming rate and it's absolutely provable if you just look at the latest flow of funds report. Furthermore, classic inflation M1 may be going up but M-prime is contracting. The government debt growth you speak of barely makes up for half of the shrinkage in the overall economy. This is the biggest deleveraging in ourlifetimes. Eventually rates will go up, but we'll be lucky if we can get back to 2003 levels within 5 years. If you're so sure why dont you short the futures and retire?