Market anxiety

When it comes to interest rates, it’s not only how high, but also how fast they rise

Interest rates have been on a gradual but steady increase since late last year. That’s generally seen as a good thing as long as the hikes are related to a strengthening economy, higher employment andmore economic activity.

The issue for investors in recent months has been whether the Federal Reserve Bank is raising rates so aggressively that it has turned down the heat on a bull market that celebrated its ninth birthday this month.

For a while, rising rates and rising stock prices had been happily co-existing.

Then a spike in rates and hints of more to come led to a 1,175point decline in the Dow Jones industrial average in February. The market swoon was caused partly by traders beginning to question whether the speed at which interest rates were rising could be disruptive for stocks.

One key long-term rate that spiked last month was the average 30-year mortgage rate.

Mortgage rates climbed to the 4.4 to 4.5 percent range and continued higher in March to the 4.5 to to 4.6 percent range — levels last seen in 2014. Also, the 10-year Treasury bond, which was at 2.43 percent a year ago, sits at 2.89 percent.

The 10-year Treasury bond is a significant benchmark because it guides other interest rates. Even the Federal Reserve watches the 10-year Treasury yield. That’s because the 10-year Treasury is sold at auction. Higher yields indicate the confidence that investors have in economic growth.

“Now that we know rates can spike to a point of spooking the market, what do we do with that information?” said Bernard Carter, managing director of investments at Hapanowicz & Associates, Downtown.

“It wasn’t the absolute level of rates that got people spooked,” he said. “It was the rate of change. It was a gradual change and then, all of a sudden, rates spiked quite a bit higher quickly.”

The team at Hapanowicz isn’t panicking.

“Our view is we are still in that healthy period where rising stock prices should coexist with rising rates,” Mr. Carter said. “But people are watching closely. They are watching data like a hawk for any additional signs that either inflation is rising or wages are rising or consumer or producer prices are rising too fast.”

The Federal Reserve raised its benchmark interest rate last week by a quarter of a percentage point to a range of 1.5 to 1.75 percent — marking the sixth time since the financial crisis of a decade ago that it has raised rates. The central bank signaled that it is on track to raise rates twice more in 2018.

The Dow Jones tumbled more than 700 points following the Fed’s rate hike announcement. The drop was partly attributed to fears of a fight between the U.S. and its trading partners after President Donald Trump said he will impose billions of dollars in tariffs on Chinese imports.

The Dow Jones closed Wednesday at 23,848.42, about 2,400 points lower than its all-time record high of 26,252.12, which it reached on Jan. 23.

Many Wall Street pros insist the stock market can thrive despite rising rates.

Others in the financial services industry are concerned that if the U.S. economy is vulnerable, the Fed’s actions could trigger a recession and a stock market selloff unless it reverses course by pausing rate hikes.

Higher rates typically take a bigger bite out of the budgets of individual and corporate borrowers, which slows down their spending.

“As the cost of money goes up, it makes it more expensive to borrow for business investment as well as buying a home,” said Paul Brahim, CEO of BPU Investment Management, Downtown. “So, it affects businesses and consumersalike.”

Higher rates on bank CDs and other savings vehicles also provide more incentive for investors to pull money out of stocks. For years, savers have been earning close to nothing from the fixed income side of their portfolios. Rising rates will finally give savers a change to earn a more meaningful return on their savings without the risk that comes from being in the stock market.

But that doesn’t mean a bear market is near, Mr. Brahim said. “Generally, as long as interest rates stay below 5 percent, stock markets have positive performance. The risk is that the Fed raises rates too fast and instead of controlling economic growth they quash it.”

P.J. DiNuzzo, president and chief investment officer at DiNuzzo Index Advisors in Beaver, said the most important rate to watch during the Fed’s rate-raising campaign will be the 10-year Treasury, which stands at 2.89 percent.

“The key would be the real rate, which is the 10year Treasury rate minus inflation [currently 2.2 percent],” Mr. DiNuzzo said. “If that rate is above 2 percent, that could have a drag on the stock market.

“If real rates were above 2 percent, then it could initiate a negative head wind on the market because it would start money moving out of stocks into bonds,” he said.

“Currently, the real rate is less than 1 percent. Rates have not reached a point where it’s a drag on the market. But the jury is still out. The question is, what will happen from here?”