Confirmed: Higher Rates Ahead

04/22/2010 12:05 pm EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of The Aden Forecast, say Treasury bonds have crossed an important threshold, and they tell how higher rates will affect your portfolio.

It finally happened.

This month we received the final confirmation that interest rates are going much higher for years to come.

As you know, we’ve been watching the 30-year [Treasury bond’s] yield closely and by breaking clearly above the 4.65%-4.75% level this month, a mega-trend change has occurred for the first time in 25 years.

Once the mega-trend turns up or down, interest rates keep going in that direction for at least a decade, and usually longer. So for the first time since the early 1980s, the era of low interest rates is over and we’ll now likely see interest rates rising for the next ten years or more.

How will this affect us?

  • First, it’s a strong sign that inflation [will] eventually become a big problem. It will be good for the metals markets as it’ll provide an ideal environment for higher prices. The same is true of other commodities.
  • On the other hand, this mega-reversal is telling us that bond prices are going to be falling for a long, long time. So, you’ll want to sell government bonds if you have them and don’t plan on buying bonds any time in the future. A small position in Treasury Inflation Protected Securities (TIPS), which adjust for inflation, would be the only exception.
  • Rising interest rates will also be bad for the stock market, but it could take some time before this happens. Why? Interest rates are rising from historically very low levels. Even if they rise a couple of percentage points in the year ahead, they’re still going to be low. At some point, however, investors will grow concerned, and that’s when stocks will feel the heat.
  • Since rates are unlikely to be as low as they are now for decades to come, we’d strongly recommend refinancing your home mortgage if you’ve been thinking about doing this. It would also be important to lock in a fixed mortgage rate.
  • As interest rates move higher, it’s going to be bad news on the fiscal front. This year’s budget deficit is already expected to hit $1.5 trillion, an all-time high. This will come on top of last year’s deficit of $1.4 trillion.

But with interest rates so low, the interest payments on the debt haven’t been a big problem. That will soon change because the cost of carrying all this debt is going to become way more expensive, ballooning future deficits even more.

  • Meanwhile, the negative financial outlook will weigh heavily on the US dollar. The growing deficits, along with inflation, will overshadow the benefit of higher interest rates. It’ll likely keep downward pressure on the dollar.

How high could rates go? For starters, we think the 30-year yield could rise to near the 7% level and the ten-year yield could approach 6%. This will be reinforced once the ten-year rate rises and stays above 4%.

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