US Interest Rates Will Continue to Rise

The interest rate on ten-year US Treasury bonds has risen almost a full percentage point in the last six months, to 2.72%, implying a loss of nearly 10% in the price of the bond. And the recent rise in long-term rates is just the beginning of an increase that will punish investors who are seeking extra yield in long-term bonds.

CAMBRIDGE – Six months ago, I wrote that long-term interest rates in the United States would rise, causing bond prices to fall by so much that an investor who owned ten-year Treasury bonds would lose more from the decline in the value of the bond than he would gain from the difference between the bonds’ interest rate and the interest rates on short-term money funds or bank deposits.

That warning has already proved to be correct. The interest rate on ten-year Treasury bonds has risen almost a full percentage point since February, to 2.72%, implying a loss of nearly 10% in the price of the bond.

But what of the future? The recent rise in long-term interest rates is just the beginning of an increase that will punish investors who are seeking extra yield by betting on long-term bonds. Given the current expected inflation rate of 2%, the real rate on ten-year bonds is still less than 1%. Past experience implies that the real rate will rise to at least 2%, taking the total nominal interest rate to more than 4%, even if expected inflation remains at just 2%.

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