What Would An Interest Rate Spike Mean To Your Portfolio?

Source: Flickr / Steve Jurvetson.

Jim Paulsen from Wells Capital Management recently said he thinks the 10-year Treasury yield will climb to more than 3.5% this year. This is a pretty bold prediction, being that the current 10-year yield is just under 2.5% and there are only seven months left in 2014.

While rates like this would certainly make bonds a more attractive investment, other areas of the economy could be adversely affected by this. Here's what a 3.5% 10-year yield could mean for housing, banking, and the overall economy, and why all investors should keep a close eye on rates.

Housing
Judging from the chart below, the 10-year Treasury rate is roughly about 1.7% below the average 30-year mortgage rate. So, if the 10-year yield rose to 3.5%, if should produce a 30-year mortgage rate of about 5.2%.

10 Year Treasury Rate Chart

This could have a profound effect on the real estate market.

Although mortgage rates are already considerably higher than the record low 3.5% 30-year rates we saw in 2012 and the first part of 2013, they are still pretty low on a historical basis. As a result, the housing recovery has been progressing nicely, with the average home price up about 25% from the 2012 lows, according to the Case-Shiller Home Price Index.

A spike in mortgage rates could halt the gains in home prices, or even cause declines.

As you can see, rising rates and home sales generally move inversely to one another, and the more drastic the rate increase, the quicker home sales will decline.So, if rates rise considerably, we'll most likely see home prices drop, or at the very least stabilize, in order to keep buyers attracted.

US 30 Year Mortgage Rate Chart

Lending
The same could be said for other types of lending, such as auto loans, home equity loans, and credit cards.

Currently, the average interest rate on a 48-month auto loan is just 2.85%, and 5.7% on a $50,000 home equity loan, according to bankrate.com. If the 10-year yield rose to 3.5%, we could see auto and home equity loan rates of almost 4% and 7%, respectively, assuming the rates increase by the same amount.

Credit card interest rates vary widely, but most cards have a variable interest rate. So, in a rising rate environment, a 17.9% rate could turn into 21.9% quite easily. This would translate to an additional $40 in interest each year for every $1,000 in credit card debt.

Source: Flickr / Scott Cresswell.

The ripple effect of lending
Not only would a spike in rates mean the banks would take in less fee and interest income, but many other businesses would be affected as well.

For example, a $50,000 15-year home equity loan at the current rate of 5.7% comes with a monthly payment of $414. At a rate of 7%, the payment rises to $449. Less people would refinance their home to be able to afford repairs. Automakers would find it harder to sell cars at higher rates. There are many industries that would be affected as a result.

If rates rise like Paulsen projects, consumers in general will be more reluctant to spend money they have to borrow. That means less credit card spending, which would adversely affect retailers, airlines, restaurants, and other service-based businesses.

How this could affect stocks
Higher rates may be what the market is waiting for, before the big "correction" we keep hearing about finally happens.

Higher interest rates are the most surefire way to slow down an economy, mainly because they affect nearly every sector of the market in a negative way. If the rise is steady and controlled, it doesn't produce too much volatility. However, a 10-year rise to 3.5% by the end of the year would be a "spike", and we could see a pretty large correction.

Top dividend stocks for any market
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.


Read/Post Comments (1) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 08, 2014, at 1:32 PM, JeanDavid wrote:

    I assume the Fed wishes to keep the inflation rate as high as they can get away with without destroying the value of the dollar. And to do that, I further assume that to keep the value of the dollar high, they must depress the value of gold. The best legal way to depress the value of gold is to sell large amounts of it when trading in gold is thin. But as the US gold supply vanishes, it is difficult to do that. Gold is accumulating in places like China, India, and Russia.

    The Fed wants inflation high so that the dollars used to pay the interest on the debt are cheaper than they were when the debt was originally sold. But if the inflation rate, as measured by the increasing dollar value of gold, gets too high, other countries will refuse dollars in payment for goods and services, and will refuse to buy treasury securities unless the interest rates are greatly increased.

    All in all, I foresee the continuing fall in the value of the dollar, so even if the stock market remains the same, or goes up, in dollar terms, investors are going to take a beating.

Add your comment.

DocumentId: 2979042, ~/Articles/ArticleHandler.aspx, 7/25/2014 1:03:01 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement