Interest rates are inching back up. Here's what that may mean for stock and bond investors.
Bad news for borrowers: Interest rates are back on the rise.
A month ago, yields on the benchmark US Treasury 10-Year note were at 2.7% while the federal government was partially shut down and it there was (light) speculation that it ran the risk of not paying its debt on time.
Once a short-term deal was reach between Congress and President Obama – and after some weak economic data – the markets decided that the Federal Reserve Bank wasn't going to taper its $85 billion monthly bond-buying known as "quantitative easing" (QE). That gave bond investors reason to hold on to and even buy some more bonds, thereby lowering bond yields which move inversely to bond prices. Yields on the 10-Year dipped below 2.5% a couple of weeks ago.
Now, however, the markets are starting to contemplate the Fed tapering QE sooner rather than later. And, now bond prices are back above 2.7% and look to be marching towards 3% once more. But will we get there soon?
Chad Morganlander, portfolio manager at Washington Crossing Advisors, thinks we're headed for higher rates and it's because he believes things are looking up in the United States. "I believe the economy is on the mend," says Morganlander. "The Federal Reserve, as they see the jobs number improving – and that's our forecast – they'll start to taper, perhaps in March of next year."
This will also lead to curbed or even lower stock prices, according to Morganlander. "When that occurs, you're going to see the bond markets start to sell off, interest rates start to rise, and that will impact equity prices in the short run," he says.
But, in the long run, Morganlander believes things will be better for stocks but not so much for bonds. "That doesn't necessarily mean it's a very bad thing," he says. "In fact, it could turn out that good news is actually good news for the equity markets. But, nonetheless, the fixed income market is a spot where investors may want to be somewhat more cautious."
In other words, you might see a healthier market but a bit higher interest rates.
"Conventional wisdom tells us that higher interest rates should be a headwind for equities, says Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson. "Fortunately, for the past 35 years we haven't had too many opportunities to test that theory."
Ross notes that three and half decades ago, the 10-Year bond was yielding 16% while the S&P 500 was around 100. On Wednesday, the S&P 500 closed at a record high of 1,782.
What's the next technical level for interest rates according to Ross? Watch the video above to see the rest of the interest rate analyses by Morganlander and Ross.
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