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Rising Treasury Yields Worrying Investors and Homeowners

AP
Thursday, 7 Jun 2007 | 4:17 PM ET

Investors' expectations of an interest rate cut--and home buyers' hopes for cheaper mortgages--seem to be disappearing.

The yield on the Treasury's 10-year note passed 5% Thursday, rising as high as 5.10% in early afternoon trading in New York, its highest point since mid-July. Some market watchers say the yield is likely to climb higher as bond prices weaken, making it even harder for consumers to finance home puchases and for companies to borrow money.

If the yield reaches 5.25%, a five-year high, it would match the Federal Reserve's current benchmark interest rate--signaling that the market is, in a sense, beating the central bank to the punch in hiking rates to curbing inflation.

The Fed has kept rates on hold since last summer, after about two years of gradual increases.

Average consumers may be asking themselves why rates are going up now, but some market watchers are asking themselves why they went down in the first place and are bracing for the rise to continue. The Fed has repeated consistently that its primary goal is to lower inflation, and because inflation has shown few signs of abating, central bankers feel hard-pressed to drop rates.

"It was a bias toward tightening, but the market didn't reflect that," said Strong Capital Management economist Jay Mueller.

Higher Mortgage Rates

Mortgage rates are rising because they're tied to the 10-year yield. Although fixed mortgage rates remain below their levels from a year ago, they have been advancing recently along with Treasury yields, adding to worries about sluggish home sales and faltering home prices.

The average U.S. 30-year fixed mortgage rate was at 6.12% Thursday, up from 5.98% a week ago, according to Bankrate.com. The average 15-year fixed mortgage was at 5.82%, up from 5.69% last week.

It's too soon to say if the trend will continue, but investors who had high hopes for a Fed rate cut this year are now pricing in their reduced expectations. Economic data has been too strong to warrant lower rates anytime soon; despite the tepid housing market, the job market has remained stable, wages keep ticking up and manufacturing activity is clawing its way back from stagnancy.

Other Treasury issues tumbled Thursday, too, driving up the two-year note's yield to 5% and the 30-year bond's yield to 5.18% in early afternoon trading.

The United States isn't alone in rising yields. Bond yields in the Eurozone, Great Britain, Japan, and other economies have advanced as central banks around the world gradually hike interest rates to limit inflation _ which appears to be accelerating now as it catches up to the strong global growth over the past few years.

On Thursday, New Zealand's central bank surprised markets by raising its key interest rate to a record high 8% from 7.75%, a day after the European Central Bank raised its key rate to the highest level in nearly six years and left open the possibility of more increases.

"Rates Are Too Low"

Jack Ablin, chief investment officer at Harris Private Bank, characterized the relatively high prices and low yields in the U.S. Treasury market over the past nine months as a bubble. "Rates are too low," he said, and predicted the 10-year yield will lift to 5.75%.

Peter Schiff, president of investment firm Euro Pacific Capital in Darien, Conn., forecasts the 10-yield will break through 5.5% by the fall and soar to 7% in about a year, pushing the average 30-year fixed mortgage rate above 8%.

Not everyone believes yields will rise that high; RBS Greenwich Capital bond strategist David Ader, for one, predicts that the 10-year yield could possibly float to 5.25%, but it then would retreat.

Still, any big upswings in the interim could squeeze Americans looking to buy a home or refinance.

"Five percent is not in itself a big deal, but a move to 5.25% or 5.5% could cause some discomfort for people taking out a mortgage," Ader said.

Damper on Wall Street

In addition to pressuring home prices, an extended increase in Treasury yields could put a damper on a big source of income for many Americans: Wall Street.

The stock market has been soaring, with the Dow Jones industrial average and Standard & Poor's 500 index reaching all-time highs. But rates affect corporate America's ability to make deals, which have been on a tear and a major catalyst behind stocks' ascent.

Ablin noted that currently, about two-thirds of the 30 Dow components have a free cash-flow yield above the benchmark interest rate. Cash-flow yield is calculated by dividing the cash-flow per share by the market price per share--the higher the company's yield, the more attractive an investment it is to buyers. If rates catch up to more companies' yields, the recent dealmaking surge, though unlikely to reverse course, could taper a bit.

"As interest rates go up, the rising tide is making more and more opportunities go under water," Ablin said. "It's going to raise the bar on what it takes to actually do a deal."

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