Tighter Credit Taking Hold
Interest rates on long-term Treasury bonds jumped Thursday to their highest level since November, amid more signs that the world’s major central banks will make credit tougher to get.
Rising U.S. bond rates may keep mortgage rates elevated, which would keep pressure on the weakening housing market.
The rate, or yield, on 10-year Treasury notes ended at 4.63%, up from 4.58% on Wednesday and the highest since Nov. 9. The yield has risen from 4.33% in mid-January.
The jump in U.S. yields Thursday was triggered in part by the European Central Bank’s decision to raise its benchmark short-term interest rate from 2.25% to 2.5%, a three-year high.
What’s more, ECB President Jean-Claude Trichet signaled that the central bank was worried about inflation in the European economy and might continue to raise rates to damp price pressures. Policymakers will do “whatever is necessary and appropriate to ensure price stability,” Trichet said at a news conference in Frankfurt, Germany.
Bond investors worldwide have been spooked this year by prospects for credit-tightening moves by the each of the “Big Three” central banks -- the Federal Reserve, the European Central Bank and the Bank of Japan.
“Generally, people realize we’re in a rising rate environment,” said Frank Hsu, a bond strategist at brokerage Fimat USA in New York.
That is causing some owners of long-term bonds to sell the securities, on the fear that they may be underestimating how high short-term rates will go.
On Thursday, the yield on 10-year German government bonds surged to 3.57% from 3.51% on Wednesday, and now is the highest since April. Bond yields rise as the securities’ prices fall.
Japanese government bond yields also have risen sharply since mid-January amid more signs that Japan’s economy is on a solid recovery track -- enough to allow the Bank of Japan to begin raising interest rates from what have been the world’s lowest levels since the late 1990s.
Early today, new data provided more evidence that Japan was emerging from a decade of deflation, or falling prices for goods and services caused by weak consumer and business spending.
The Japanese government said its index of core consumer price inflation rose 0.5% in January from a year earlier. Analysts had expected a 0.4% increase.
Many bond market pros expect the Bank of Japan to announce as early as next week that it is shifting its policy, in what would be the first step toward tightening credit. The bank’s benchmark short-term rate now is effectively zero, compared with the U.S. Federal Reserve’s benchmark of 4.5%.
A popular investment strategy with hedge funds and other sophisticated investors in recent years has been to borrow at rock-bottom interest rates in Japan and invest that money in higher-yielding bonds in the U.S., Europe and elsewhere, a practice known as the carry trade. Tighter credit in Japan could make that strategy less profitable -- unless bond yields in other countries were to rise to compensate for higher Japanese rates.
“If Japan is stepping back [from easy money] world interest rates may be higher than they’ve been,” said Christopher Wiegand, an economist at Citigroup Global Markets.
That could be particularly troubling for the U.S. housing market, which has shown more signs of slowing in recent months. Conventional mortgage rates tend to move in tandem with the 10-year Treasury yield.
The average 30-year mortgage rate dipped this week to 6.24% from 6.26% the previous week, but is up from 6.15% in mid-January and 5.53% early in July, according to mortgage finance giant Freddie Mac.
The cost of adjustable-rate mortgages has climbed even more steeply since July, as the Fed has continued to raise its key short-term rate.
The average rate on one-year adjustable-rate mortgages was 5.34% this week, up from 4.24% early in July, according to Freddie Mac.
If long-term bond yields rise further, pulling conventional mortgage rates higher, it could make it more difficult for homeowners who have adjustable-rate loans and were hoping to refinance into fixed-rate loans.
Some investors have been betting that long-term U.S. bond yields would remain level or decline this year. That assumption was based on expectations that the Fed would slow the economy, and inflation, by continuing to raise short-term rates.
But apart from housing, the economy hasn’t shown significant weakness this year. And Fed officials, like their European Central Bank counterparts, have vowed to focus on restraining inflation, even if that would mean higher interest rates.
Jay Bryson, global economist at Wachovia Corp. in Charlotte, N.C., said the mood at the central banks raised the odds that long-term bond yields “are going to be higher by year-end than they are today.”
