Higher interest rates to touch many sectors of economy

End of Fed bond program will touch many sectors of economy

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WASHINGTON — All it took was speculation that the Federal Reserve could slow its bond buying months from now – and then a few words Wednesday from Chairman Ben Bernanke to confirm it.

The result is that record-low interest rates that have fueled economic growth, cheered the stock market, shrunk mortgage rates but punished savers are headed up.

Suddenly, long-term borrowing rates, though still historically low, are rising. And once the Fed starts scaling back its bond purchases, those trends could accelerate.

Here’s how higher rates will affect consumers, businesses, investors and other players.

CONSUMERS: The main impact on consumers will likely be higher mortgage rates. Rates on auto loans, student loans and credit cards probably won’t rise much soon. They’re more closely tied to the short-term rate the Fed controls. That rate isn’t expected to rise before 2015.

The average rate on a 30-year mortgage jumped from a record low of 3.31 percent in November to 3.98 percent last week, according to mortgage giant Freddie Mac. That’s the highest point in more than a year.

Higher loan rates would allow banks to make more from mortgage lending and could lead them to lend more freely.

“The irony is that higher rates are likely to mean more people can get mortgages,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank.

SAVERS: Savers aren’t likely to enjoy much benefit soon. Banks already have plenty of deposits and don’t need to boost rates on CDs or bank accounts to attract more cash, said Greg McBride, a senior financial analyst at Bankrate.com.

BOND INVESTORS: As rates rise, bond investors can lose principal as the value of their existing bonds declines. Investors in bond funds, especially those with long-term holdings, are most at risk. The Pimco Total Return fund, the world’s largest mutual fund with $285 billion in assets, has lost 3.3 percent in the past month.

Marilyn Cohen, president of Envision Capital, fears that baby boomers will pull out of bond funds as fast as they rushed into them. If so, that could send bond yields rising further in a cycle of selling spurring more selling.

HOMEBUILDERS: Higher mortgage rates could lower demand for new homes. The stocks of leading builders like Toll Brothers, Lennar and D.R. Horton all plunged Thursday far more than the stock market as a whole.

But many builders say they remain optimistic. They say higher rates will encourage potential buyers to get into the market before rates rise further.

SMALL BUSINESSES: Higher rates could further depress loan demand at many small businesses, at least in the short run. But higher rates can also benefit small business because they signal that the economy is strengthening. Once companies make more money because they have more customers, they’re more inclined to expand or buy equipment, even though financing is costlier.

BIG BUSINESSES: Large U.S. companies have sold more than $4 trillion in bonds to investors in the past 2½ years, according to Dealogic, a research firm. As rates began rising last month, new sales slowed. Companies with top credit ratings sold only $9.5 billion in bonds last week.

Still, companies have been collecting record profits. That means they should still be able to expand their businesses and hire more, even if borrowing costs rise.

PENSION FUNDS: Rising rates are a relief for companies with employee pensions. Accounting rules require them to use bond rates to determine how much money to set aside so they’ll be able to pay retiree benefits in the future.

When rates are low, rules require companies to set aside more money because their bond holdings produce little interest. Conversely, higher rates help: Companies can earn more on their bonds, so they don’t have to invest as much.

A small increase in rates can produce big savings. The Pension Benefit Guaranty Corporation, a government agency that takes over troubled company pensions, must pay $110 billion in future benefits. It estimates that a 1 percentage point rise in rates would reduce the amount it needs to invest today by 10 percent, or $11 billion.

GOVERNMENT DEFICIT: The federal government — the nation’s biggest borrower, with a $17 trillion debt — might have the most to lose from higher rates. The super-low rates of the past few years have given the government a break at a time when the annual deficit was soaring.

After four years of $1 trillion-plus deficits, the nonpartisan Congressional Budget Office has forecast that the deficit will shrink to $642 billion this year. That would be down from $1.09 trillion in the 2012 budget year.

The CBO factored higher rates into its forecasts. But some economists say it might not have anticipated how high rates might go. The 10-year Treasury averaged 1.8 percent last year. The CBO expects it to average 2.1 percent this year, 2.7 percent in 2014 and keep rising to 4 percent by 2018.

Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University, said those projections now look low. Still, Sohn said other trends could offset the rate rise.

“On balance, a stronger economy generating more tax revenue will be far more beneficial than the higher cost of debt,” he said.

Last year, the government paid $220 billion in payments on the publicly held part of its debt. The CBO thinks that figure will be only slightly higher this year but will more than double by 2018.


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