Era of falling interest rates appears to be over

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.

That has fueled worry of a dampening housing market — now a key driver of economic growth after years of being a drag on the recovery. Recent gains in home prices have provided an important lift to consumer confidence and spending, which makes up about 70% of U.S. economic activity.

For Ratha Kelly, a teacher in San Diego, talk of higher mortgage rates prompted her and her husband to buy a condominium now rather than wait a few more months. They locked in a 3.25% rate after their lender said it could soon go to 4.5%, and they expected to close on the deal Tuesday.

“We’re very lucky,” said Kelly, 29, who had expected rates to stay the same for another year. “We felt like we got in just at the right time.”

Analysts disagree over whether higher mortgage rates could wind up stalling growth. In the short term, it could push potential buyers into the market to lock in rates before they rise further. Longer range, the central question is, how will the economy be performing as rates climb back to historically normal levels?

“If ... we are booming and the economy is up and people are having jobs and profitability is high, which is what happens when the economy starts to grow rapidly, no one is going to care,” Jamie Dimon, chairman and chief executive of JPMorgan Chase & Co., said at a recent financial industry conference in New York.

Long-term interest rates peaked in the early 1980s with the 10-year Treasury yield averaging nearly 14% in 1981. It has fallen most years since then, to 7% in 1992, to 4.6% in 2002 and to 1.8% last year.

“That’s done, that’s over,” said Mark Zandi, chief economist at Moody’s Analytics, referring to the long downward spiral.

The key now, he said, is whether the Fed can guide, with words and actions, a slow and orderly rise in interest rates that would avert a big blow to the housing market or panic selling by bond investors.

For investors in general, Zandi said, the coming end of ultra-low interest rates means that stocks, houses and other asset prices won’t be growing as quickly as they did in the past when falling rates spurred investment in riskier assets.

Yet many ordinary savers, especially seniors, are waiting for higher interest rates.

Larry and Eleanor Cohen, retirees in Vista, said they have saved all their lives and kept all but a small percentage of their nest egg out of the stock market, fearful of a sharp decline. But certificates of deposit and other savings accounts have paid next to nothing in interest in recent years.

Eleanor Cohen, 72, remembers CD rates at 12% about 25 years ago. She hopes interest rates will rise to at least above the level of inflation.

Her husband, Larry, 76, said it has been like “watching your future security gradually ebb away.”

“It’s like a tide going out,” he said. “You wonder: The longer you live, what will be left?”

Lee reported from Washington, Tangel from New York and Reckard from Los Angeles.