What’s Up With Interest Rates?

A couple of weeks ago, I blogged about how interest rates in the U.S. are starting to go up. At that time, we had gone from 1.6 percent to 2.1 percent, and I said that 32 percent rise was a big deal. Now, here we are a couple of weeks later, and interest rates are now at nearly 2.5 percent.

That’s about a 50 percent move overall, and it’s an even bigger deal than the increase I wrote about earlier. When I predicted rates were going to continue to go up, I didn’t think it would happen so fast!

The upward pressure on interest rates stems from what the Federal Reserve is saying about the economy. Last Wednesday, Fed Chairman Ben Bernanke again hinted that the Fed might reduce the stimulus it’s providing to the economy via ultra-low interest rates and bond-buying activity by the end of this year. Interest rates are moving in anticipation of this event.

Here are the two ways this might play out.

1. If, and this is still an if, the economy continues to grow stronger in the next six months and the unemployment rate comes down (from 7.6 percent to the lower 7 percent range), then the Fed will likely begin the process of removing stimulus. In this scenario, the economy and job market are stronger than they are today, which should be a positive for businesses that might increase hiring and boost wages for employees.

2. If the move we have already seen (50 percent higher rates on the 10-year U.S. government bond) begins to slow the economy down, then the Fed might maintain the stimulus at its current levels. Consider this: Rates on a 30-year fixed mortgage have gone from 3 percent to 4 percent already. Consider a traditional 30 year-fixed loan payment on a $250,000 mortgage. A new homeowner’s payment (at 4 percent) would be $1,194 a month. A monthly payment on that same house for a homeowner who closed just a couple of months ago would have been $1,054. That’s an almost 15 percent increase already!
While these rates are still historically low, a change this dramatic could impact the housing market, which is still getting back on its feet. Purchasing may slow down, and prices will increase.

Although accurately forecasting the magnitude, time frame and direction of interest rates is a fool’s game, I feel confident in saying that the rise in rates over the next six months will be relatively limited.

Why? If it continues at this rapid pace, it will put a big dent in the very recovery the Fed has tried to create over the last four or so years.

Either way, we know the Fed is going to continue to support the economy as long as possible. If the economy picks up, they can step back. If it worsens, they can increase the dosage of the medicine they’re already providing.

From here, the economy may have a steadier trajectory than interest rates themselves. But another 1 percent spike in rates over the next few months is unlikely.

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