Tuesday, January 25, 2005

A BIG RISE IN INTEREST RATES COULD COST YOU A BUNDLE


By JOHN CRUDELE, The New York Post

January 25, 2005 -- THAT ticking noise I men tioned in my first column of 2005 did turn out to be the sound of time running out for the stock market rally.

But the real noise you should be listening for is the air coming out of bonds.

You say that you never invest in bonds so you really don't care?

Well, I wouldn't turn to the sports pages just yet.

You have a bigger bet on the bond market than any wager you could possibly place on next week's Super Bowl. (By the way, Eagles 24, Patriots 10)

First, here's something very basic. When the price of a bond goes down, the (yield) interest rate goes up. That's automatic, like the two ends of a teeter-totter going in opposite directions.

Last spring I said the economy wasn't as strong as Washington was pretending, so interest rates wouldn't go up. I was mostly right.

What happened was highly unusual. The Federal Reserve has been trying to raise interest rates by boosting the so-called Federal Funds rate five times.

The sixth hike may be on the way in early February.

But borrowing costs in the real world haven't moved very much.

While savers can get a little more interest on short-term certificates of deposit, you'll pay nearly the same rate on 30-year mortgage now as you did last summer. Same for car loans and money borrowed longer than a few months.

Astoundingly, the financial markets did not obey the dictates of monetary regulators.

The real world has told Alan Greenspan that he and his Fed colleagues are out of step with reality.

So here's the big question for 2005: Will bond prices finally get hammered because interest rates are rising in accordance with the Fed's wishes?

The value of your home or apartment could very well decline if borrowing costs go up. If rates rise substantially, the housing bubble that everyone else has been worrying about could burst.

The second problem that higher rates could cause would come by way of the stock market.

If interest rates climb, companies will join everyone else in paying more to borrow money.

And if borrowing costs increase, corporate profits will decline. Investors — already in a bad mood — won't like that.

But the big question is: Will interest rates climb?

The answer is, I don't know. Nobody does. Working in favor of rates staying down (and bonds up) is the fact that the nation's economy is growing modestly.

The big issue is that there are several substantial problems that could spook bond investors into demanding higher rates.

First, the Fed wants rates up. That alone could eventually be enough to boost borrowing costs.

The extremely weak dollar may lead foreign investors to demand higher rates on their money.

You already know all the other problems: the U.S. trade deficit, the federal budget deficit, the war in Iraq and Social Security concerns.

Any one problem on its own could jolt interest rates if investors become nervous enough. So, will rates go much higher?

If you grabbed my feet and started tickling until I gave an answer, I'd say there's a slightly better than even chance that they will.

But the odds are only that close because of something we Americans should be proud of: even with all those problems, foreigners still think their money is safer here than anywhere else. And they are willing to accept less of a return for that peace of mind.