Term Sheet

The latest on private equity, M&A, deals and movements — from Wall Street to Silicon Valley

The real reason interest rates are rising

June 14, 2013: 9:04 AM ET

Inflation isn't rising and the job market, while doing better, is creating just enough jobs to keep up with population growth. So why are rates rising?

What will Bernanke do next?

What will Bernanke do next?

FORTUNE -- A curious thing is happening with interest rates -- often the single-most critical influence behind economic and business decisions. Since the financial crisis, the costs of borrowing have sunk to historic lows after staying relatively low for the most part since the early 1980s.

But that's changing, as rates are rising again. And it's unexpected because interest rates charged by lenders, in general, rise when the economy is either doing pretty well or pretty badly. Needless to say, the economy is doing neither. It's indeed improving, but more than that, it's merely idling along with 7.6% unemployment and millions of people without jobs.

There are few, if any, signs of inflation, which generally coincides with a faster growing economy and a run-up in borrowing costs. Higher rates also follow signs of an economy in distress, but any fear that the U.S. is falling back into a recession has largely subsided.

And yet, as investors brace for what some say could be a new era of higher interest rates, global markets in bonds, currencies, and stocks have experienced bouts of turmoil.

Yields on Treasury securities and mortgage rates have surged: Earlier this week, Treasury prices fell, pushing the yield on the benchmark 10-year Treasury note as high as 2.29% -- its highest level since April 2012. Because mortgage rates typically follow 10-year notes, the cost of home loans has steadily risen, too.

MORE: The Fed's other trillion-dollar problem

For the sixth week in a row, the popular 30-year, fixed-rate mortgage rose closer to 3.98% this week, bringing the rate closer to the 4% mark, according to mortgage finance company Freddie Mac. That compares with 3.91% last week and 3.71% a year ago.

So why are rates rising?

Investors are confused, or simply overreacting, as many try to figure out what the Federal Reserve will do next, says Dean Baker, economist and co-director of the Center for Economic and Policy Research. For several years now, the central bank has kept interest rates super-low by buying up billions of dollars worth of bonds. Ideally this would help the economy grow by encouraging businesses and consumers to borrow and spend more, but Fed Chairman Ben Bernanke on May 22 hinted the Fed could scale back buying soon.

But before the Fed even makes any big bold moves, many investors are acting as if the central bank will stop the money spigot entirely. They've been reducing their exposure to bonds, which has helped push up rates. "I feel like investors are jumping the gun on this," says Baker, adding that it's unlikely the central bank would slow the pace of its bond purchases. Inflation isn't rising, and the job market, while doing better, is creating just enough jobs to keep up with population growth.

MORE: The rebirth of Fannie and Freddie

At a meeting on Tuesday and Wednesday, Fed officials will weigh what it may do next. Even if members of the Federal Open Market Committee promise to continue with its $85 billion in monthly asset purchases, that may not stop interest rates from continuing to rise.

Either investors think the Fed is bluffing, or they're starting to think the economy is doing far worse than many of us think. Whatever the confusion, if it continues, new home buyers and other borrowers may have to pay for it.

Join the Conversation
About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

Email | @ninhaitseng | RSS

Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.