While all eyes are focused on the rising stock market, the bond market is staging a quiet rebellion. Interest rates are rising inexorably, despite pronouncements from Fed Chairman Powell that there is no inflation in sight, at least for the next three years.
Still, bond buyers are demanding slightly higher interest rates, especially when it comes to buying longer-dated bonds. The 10-year Treasury note, which briefly yielded a shockingly low 0.54% in the depths of the pandemic, has risen to 1.5% recently.
In the bond world, that is a huge move upward in yield. When the world was literally falling apart last spring, those seeking safety were willing to accept very low yields in exchange for the security of owning our government debt. Now, not so much.
While you might not care much about the intricacies of the multi-trillion dollar government bond market, it will impact you, whether you’re a saver, a spender, or a younger American who will have to work and pay taxes to pay the interest on our National Debt down the road. So, it’s worth paying attention.
MEGO numbers – My Eyes Glaze Over!
Here’s a startling fact. Last year the government spent $345 billion just paying interest on the National Debt. Interest on our debt equaled 5.3% of total federal spending. Because of low interest rates, the interest burden was manageable. But our National Debt will grow by $2 trillion this year. It has been conservatively projected that interest payments will cost the government $914 billion in 2028. That’s nearly $1 trillion in one year!
Interest on the national debt will become the largest category of government spending by 2048 – larger than Social Security and Medicare. So while the debt may be manageable at today’s low rates, if bond buyers demand more interest to buy our IOUs, the cost will be enormous.
Why Rates Rise
Rates rise out of fear of the future value (buying power) of a currency. We call that inflation. Those concerns are priced every week as the Treasury borrows more money, by selling bills notes and bonds. Fear or optimism are priced around the clock in the huge global bond trading market.
Interest rates may also rise out of optimism that future growth will get the economy moving again, creating demand for money. Some of the current rise in rates comes from the success of the vaccine, and estimates that growth will resume. More economic activity would generate more tax revenues, cutting the need for government spending and perhaps lowering our budget deficits.
So far, the Fed has been able to purchase enough of our debt (often by creating new money/credit) to keep interest rates from rising. But ultimately the bond market will have its say on the real price of U.S. money. But we must be aware of the possibilities.
Impact of Rising Rates on Your Finances
Now is the time to buy a home or refinance a mortgage, locking in a low fixed rate. Mortgage rates are closely linked to rates on the 10-year Treasury note, so 30-year fixed rate mortgages have already popped up over 3%.
Interest rates on all floating-rate debt will rise, as well. Despite current high rates on credit card debt, expect to pay even more interest.
Savers may be excited about the prospect of higher rates, but that won’t happen quickly. There is so much money around that banks don’t need to post higher rates to attract deposits.
But if you own bonds, this is the time to be wary. Even top-rated government bonds, or a mutual fund that owns bonds, will see prices fall when interest rates rise. In times of rising rates, bonds are not a safety net.
As for the stock market and interest rates, that is the true enigma. It’s said that higher rates are “bad” for stocks, making other investments more attractive. But if rates are rising because of good economic growth prospects, the stock market could rise along with interest rates.
It’s never easy to forecast the stock and bond markets. But it’s important to know how they interact. And that’s The Savage Truth.