It seemed so obvious. With the economy slowly recovering last year from the worst recession in decades and the federal government seeking to tap the credit markets for over $2 trillion to fund an ambitious spending program, both laymen and experts alike seemed to agree that interest rates had nowhere to go but up. The yield on the ten-year U.S. Treasury note as of June 30, 2009 was 3.52%, down from 5.25% in June 2007, but well above the 2.09% level registered amidst the depths of the credit crisis the previous December. With retail sales and housing activity showing signs of gradual improvement, the only question appeared to be how much higher interest rates would go.
Among fifty economic forecasters surveyed by the Wall Street Journal in June 2009, forty-three expected the ten-year U.S. Treasury note yield to move higher over the year ahead, with an average estimate of 4.13%. Seven expected a rate of 5.00% or higher while only two predicted rates to fall below 3.00%. What was the result? The ten-year Treasury yield slumped to 2.95% on June 30, 2010 and rates on 30-year mortgages fell to their lowest level since Fannie Mae began tracking them in 1971.
Some observers may be tempted to poke fun at these hapless “experts,” implying they are incompetent or poorly informed. However, a more useful explanation is that even the most talented analysts are unlikely to make reliable predictions about the markets, and the poor showing by this particular group is simply what we would expect to see, just as often as not, if markets are working freely and fairly. Today’s interest rates already reflect expectations for tomorrow’s business conditions and inflation, and these interest rates will move higher or lower in response to unexpected events, not the information that everyone already knows.
The message for investors is simple. Predicting interest rates and bond prices is no easier than predicting stock prices, and making decisions based on what appear to be certain outcomes at the time can often prove costly.
As always, we welcome your questions, comments and suggestions for future topics.
Article adapted, with permission, from Weston Wellington, “Rates Can Only Go Higher” July 12, 2010.
Yahoo! Finance www.yahoo.com accessed July 7, 2010. Wall Street Journal Forecasting Survey www.wsj.com accessed July 7, 2010.Prabha Natarajan and Matt Phillips. “Stocks Drop; So Do Mortgage Rates” Wall Street Journal, June 25, 2010.
Mark Gongloff. “Two Treasury Forecasts: a Grand Canyon-Sized Gap” Wall Street Journal, April 10, 2010.
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