It won't match the fanfare surrounding Dow 11,000. But the fact that yields on 10-year treasury notes climbed back above the 5 percent threshold this morning marks a significant development for investors.
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For starters, 10-year treasuries, which are now paying out 5.03 percent, haven't yielded this much since June 2002. On paper, the fact that bonds are paying out higher yields would seem to make them more attractive.
But it's a mixed blessing. For buyers of individual treasury bonds, for instance, this is certainly welcome news, as it means individually held bonds will be throwing off more cash. But for bond fund investors—those who get their fixed-income exposure through a mutual fund—rising rates are actually bad news. That's because the price of older bonds falls when new bonds begin to pay out higher yields. This has the effect of lowering the total value of bond fund portfolios.
Rising bond yields are also bad for housing-market investors. That's because yields on 10-year treasuries help set market rates for 30-year mortgages. With long-term-bond yields climbing, expect the average 30-year fixed-rate mortgage to rise even higher than the current average of 6.43 percent.
It's no surprise that market interest rates are rising. Investors have been bracing for higher long-term rates ever since the Federal Reserve began hiking short-term rates in June 2004. Then, the federal funds rate, a key short-term rate, was at 1 percent, while the 10-year note was yielding around 4.7 percent. But as the Fed methodically raised short-term rates to 4.25 percent by the end of 2005, long-term rates had actually fallen to 4.39 percent.
This is what former Fed Chairman Alan Greenspan described as his "conundrum." Many economists, including new Fed Chairman Ben Bernanke, theorized that long-term rates weren't moving in lock step with short-term rates (as they normally do) because so many foreigners were parking their money in U.S. treasury bonds.
But since the start of the year, yields on 10-year treasuries have finally begun to kick up, from 4.39 percent all the way to 5.03 percent this morning. This reflects the fact that the U.S. economy continues to grow at a better-than-expected clip. And fast-growing economies typically produce inflation, which is enemy No. 1 for bond investors.
Don't be surprised if long-term rates continue to rise, as the Fed is expected to lift short-term rates at least once or twice more to combat inflationary pressures brewing in the economy.
