NEW YORK (MainStreet) — A year ago, most economists and market experts said interest rates would rise in 2010 as the economy got stronger. It took longer than most predicted, but rates have begun to nudge up. And now the seers say rates will go even higher in 2011.
That could be good news for savers, but not such good news for mortgage shoppers and other borrowers.
The Wall Street Journal found in a survey of 17 bond dealers that the expected average yield on the 10-year Treasury note is projected to rise to 3.5% by the end of 2011, compared to 3.4% today and 2.4% in early October. Three of the firms surveyed said the yield could go as high as 4% and one forecast 5%.
None of these rates is very high by historical standards, but a couple of years ago, the rate was down around 2%. Rates are still so low there’s a better chance they’ll go up than down.
For fixed-income investors, it might be a time to emphasize bank savings over bonds, as a bond purchased today would lose value if newer bonds offer better yields next year. Investors with bond funds should look to a figure called “duration,” which estimates how much the fund’s share price would fall if interest rates went up. A five-year duration, for instance, means the fund could lose 5% of its value for every one-point rise in prevailing rates. The shorter the duration, the lower the risk.
While bond funds, especially long-term bond funds, pay higher yields than bank savings, interest earnings could be wiped out by falling bond prices. With bank savings, principal is insured against loss, making savings a safer bet during periods of rising yields.
And, if you are lucky, bank yields may improve in the coming year. If you want to bet on that, it probably makes sense to stay flexible. Five-year certificates of deposit average 1.582%, according to the BankingMyWay survey. While that’s a lot better than the 0.252% paid by the average money market account, you might do better during the next five years by using the money market now and waiting a few months for CDs to pay more.