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Is Good News Bad For Interest Rates?

While Federal Reserve officials today reiterated their goal to keep interest rates low until at least 2014, analysts say the recent spate of positive economic news could push them up much sooner.

The Fed sets short-term interest rates, and can influence the long-term bond market through bond-buying programs. But investors could disrupt those efforts by dumping long-term Treasury bonds to buy stocks, advisers say – a likely scenario if the economy and markets continue to improve. The latest GDP figures show that the economy grew at about 3% in the fourth quarter of 2011, businesses added more than 200,000 jobs last month and retail sales grew in February at their fastest pace in five months. “We think interest rates will start to move up before the Fed moves,” says Sam Wardwell, investment strategist for Pioneer Investments.

The positive reports have already pushed rates on the 10-year Treasury bond up slightly over the past few weeks from 1.92% in the last week of February to 2.1% on Tuesday, says Greg McBride, senior financial analyst for Bankrate.com.

Inflation fears could also move rates higher. When Fed Chairman Ben Bernanke announced in the fall of 2010 that the Fed would buy long-term Treasury bonds in an effort to help spur the economy, investors who were worried about inflation began to sell long-term Treasurys. The shift  resulted in higher Treasury yields in the following months. Some investors are also skeptical the Fed will stick to its own timetable of not raising short-term rates until late 2014.

Of course, experts say the good news may not last. If gasoline prices rise sharply, that pressure could hurt consumer spending and slow the economic recovery. And some economists expect growth to slow from 3% at the end of last year to 1% to 2% this year. “Many of the things that are leading the economic news to be good are probably temporary,” says Kate Warne, investment strategist for Edward Jones.

For investors, an increase in interest rates would lower the prices on long-term bond and lead to losses. Wardwell recommends that investors shift some of their bond allocation to stocks, which should benefit as rates rise. Within bond portfolios, he advises clients to increase their exposure to investment grade and high-yield corporate bonds, which would see milder price declines.


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    • In 2010 interest payments were 6.7% of the federal budget. The 10 year bond was around 3%. If rates were to go up to 6%, interest payments would be 13.4% of the federal budget. We already have a deficit problem.

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