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Era of falling interest rates appears to be over

After 3 decades in which borrowing costs mostly have declined steadily to rock-bottom levels, the long-term path of interest rates is headed up, experts say.

June 18, 2013|By Don Lee, Andrew Tangel and E. Scott Reckard, Los Angeles Times
  • In congressional testimony and other public remarks, Federal Reserve Chairman Ben S. Bernanke and other Fed officials have talked as though they were preparing to scale back the stimulus very soon, which has confused and unnerved Wall Street. Above, Bernanke leaves a hearing before the Joint Economic Committee on Capitol Hill in May.
In congressional testimony and other public remarks, Federal Reserve… (Alex Wong, Getty Images )

For all the mixed messages from the Fed and the uncertainty that has roiled financial markets recently, one thing looks very clear: The era of declining interest rates is over.

After three decades in which borrowing costs for Americans have pretty much declined steadily to rock-bottom levels — easing consumer debt burdens for cars, homes and college education — the long-term path of interest rates is now at a turning point, according to many economists and investors.

Regardless of the Federal Reserve's statement and its economic outlook to be issued Wednesday and the market's reaction to Chairman Ben S. Bernanke's comments at his quarterly news conference, the reality is that the flood of easy money is ebbing and the economy is shifting to a new period of rising rates.

"It's a seismic shift," said Jack Ablin, chief investment officer at BMO Private Bank. "It seems this is really, in many respects, the end of the line."

The recent jumps in bond yields and mortgage rates have put the shift in sharp relief, although the Fed's muddled communications on its stimulus program contributed to the sudden run-up.

Underlying the market jitters are worries about the effect on the housing market and the increased risks of various assets. Hedge funds and other large institutional investors are starting to unload long-term bonds before interest rates rise and reduce their value.

"They're going to be dumping before they get caught with huge losses," said Richard Lehmann, founder and president of Income Securities Advisors Inc., a Florida investment advisory and research firm.

Tommy and Luanne Nast have a hybrid mortgage on the Oxnard home where they live with their two children. Their mortgage started out at a fixed rate for five years before it turned adjustable three years ago.

Their rate remains under 3%, but Luanne Nast began to panic after hearing news of long-term fixed mortgage rates shooting higher. On Tuesday, she called her mortgage broker and told him to refinance the couple's mortgage as soon as possible.

"I want to get into a fixed rate — and hopefully stay under 5%," she said. "We're waiting to see what happens with Bernanke."

Interest rates could dip back down depending on Bernanke's comments and on upcoming economic data, particularly the important monthly job-growth numbers. But those events still probably will be blips on a rising curve rather than a lasting trend.

"In a way, all this analysis or parsing of words is irrelevant," said Chris Rupkey, chief financial economist at the Bank of Tokyo-Mitsubishi in New York, referring to various Fed statements and public remarks that have confused investors. "We have reached a juncture, a turning point where there is no return."

To some extent, the rising rates reflect the gradually improving American economy. Although still lackluster, the 4-year-old recovery has settled into a fairly steady cruising speed, growing at about 2% a year.

Economic growth is widely expected to pick up toward the end of the year as the effects of the so-called sequester budget cuts fade.

That's also when analysts think the Fed will begin to reduce its massive bond buying. The $85-billion-a-month purchases of Treasury and mortgage-backed bonds have helped hold down interest rates, but the central bank is nearing its stimulus endgame, and has increasingly hinted as much.

As a matter of policy, which is expected to be reaffirmed Wednesday, the Fed has said it will maintain its bond buying program until there is a "substantial" improvement in the labor market outlook. On average, job growth has changed little in recent months, averaging about 175,000 a month, just as it has over the last year.

But in congressional testimony and other public remarks, Bernanke and other Fed officials have talked as though they were preparing to scale back the stimulus very soon, which has confused and unnerved Wall Street.

The benchmark 10-year U.S. Treasury bond yield was 1.66% in early May, but by the end of the month it had vaulted to 2.16% — a huge jump in a market where investors measure rates by microscopic movements. Since then the 10-year yield has bounced up and down; it inched higher Tuesday to 2.2%.

Mortgage rates, which are tied to 10-year Treasury yields, have crept up as well.

The typical 30-year fixed-rate home loan, which crashed below the once-unthinkable 4% level in October 2011, jumped to 3.98% last week from 3.35% in early May, according to Freddie Mac's widely watched survey. Another firm that surveys rates, HSH Associates, said the average this week was 4.15%.

The recent surge reflects "uncertainty about the Fed's next steps rather than a true increase in the level of rates," said Michael Fratantoni, chief economist for the Mortgage Bankers Assn. Even so, the trade group is forecasting that rates will trend higher over the course of this year.

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