Rising Rates Pinch Consumers

The recent uptick in long-term interest rates may signal that the end of a long period of cheap credit is at hand. That means the economy is humming, but what would higher interest rates mean for consumers?

Government statistics show that consumer spending levels have been higher than income levels for years, prompting economic worrywarts to conclude that an eventual slowdown in consumer spending levels is inevitable. If interest rates make a sustained move to the upside now, that thesis will be put to the test.

"The employment market is healthy, but consumer liquidity, which has been supporting consumer spending growth above the level of income growth, is drying up," says Colin McGranahan, a retail analyst with Sanford C. Bernstein. "A steepening yield curve only accelerates that. It makes me think that this might push down on the consumer spending deceleration button in the coming months."

The yield on the 10-year Treasury note was recently hovering near 4.9%, a level it hasn't reached in almost a year. Some investors say it's headed for 5%, which would mark its highest level since 2002.

For most of last year the yield on the 10-year stayed at 4% to 4.5%, even while the Federal Reserve moved short-term rates into that range. Normally, such a move by the Fed would goose longer-term rates higher, because bond buyers typically demand a higher rate of return for a longer time horizon on their investments. When this didn't happen, now-retired Fed Chairman Alan Greenspan famously called the situation a "conundrum."

The plot thickened late last year when short-term rates climbed higher than long-term rates, creating an inverted yield curve. Inverted yield curves have, in the past, signaled the onset of an economic recession. This time around, Greenspan voiced the widely held opinion that foreign demand for long-term U.S. bonds was pushing down long-term rates, so the inverted yield curve wasn't a sign of an economic slowdown.