Friday, March 25, 2005

The Rise of Interest Rates

For nearly two years I have predicted interest rates will rise. Of course I was not alone in my prediction, pretty much everybody thought the same. We were all wrong for nearly two years, which just goes to prove you can be right about something, just not right about when it will happen. For example, I could predict that American will have another terrorist attack, but if I can't tell you when, am I really making a prediction?

Short term interest rates have actually been rising for the past year, at the end of March last year the 90 day treasury bill was yielding .96%, which meant money market accounts were yielding about half that, some of them yielding nothing. However, as of yesterday the 90 day treasury bill was yielding 2.70% and you can get a money market account paying 3.25% at In other words, short term rates have nearly tripled in the last year. This marks one of the fastest rises of short term interest rates in history.

Long term interest rates on the other hand stayed pretty much the same throughout the year. The ten-year for a short period jumped up to the 4.80% range, but then quickly fell back down to the 4% level and didn't budge.......that is until February. Since February the ten-year treasury has risen to 4.63% (as of 3/22/05), not a huge rise, but one worth noting as it will add nearly 3/4 pt to a mortgage loan.

The real question is whether or not the trend will continue. It appears that if Greenspan has his way it will. What most people don't know is that Greenspan mostly has control over short term rates, long term rates are determined more by the market than what Greenspan wants. Thus there is the possibility that short term rates could continue to rise, while long term rates stay in the mid 4 - 5% range. This would actually hold the best of both worlds scenarios, good returns on short term bonds, and good rates on mortgages. My first mortgage was 7.75% and I thought I was getting an incredible deal, of course my loan was only $163,000. If rates rise I think new home buyers will still be able to squeeze into a home, but they will start having a harder and harder time.

What does this mean for your portfolio? Well, your bonds and bond funds will take short term hits to their principal, but will start earning higher interest rates as interest and maturing bonds are reinvested into new bonds paying higher rates - in the long run rising rates are good for bonds and bond funds especially (despite what most illiterate financial advisors will tell you).

There it is, my treatise on interest rates for the end of the 1st quarter, nothing fancy, but things are starting to look up......rates that is!

Till next time,