Thursday, April 13, 2006

Interest Rate Jitters

The yield on the 10-year has spiked today above the psychological 5.0% level. This is the highest rate since mid-2002. But it is not that high of an absolute level when looked at in a historical context. It only appears high in comparison to the unsustainably low rates when the Fed took the fed funds down to 1.0%.

There is a lot of talk in the media about rising rates and what this means for the economy and the markets. First of all, the reason that rates are rising is because the economy is strong. True, if the Fed were to take short-term rates too far, it would likely kill the economy and the market as well.

Second, if the futures market are already pricing in that fed funds is going to 5.0%, it is reasonable to expect the 10-year to rise above that rate, unless you thought the curve would stay inverted.

So I think the adjustment is that the Fed will take rates to 5.0% - 5.25% (hopefully the former), and the yield curve will maintain a modest positive slop, which would put the 10-year in the 5.25% -5.5% range.

I would prefer that the adjustment occurs quickly, rather than gets dragged out in a prolonged process that weighs on the market. If you have been keeping your bond maturities short, then we might be finally getting into a range where you can look at some longer maturities that actually have some higher yields.


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