The cost of borrowing inching up

Mortgage rates in the US increase, and short-term rates rise overseas.

from the June 11, 2007 edition

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"If we get this, it is above the Fed's target, which means the Fed can't lower rates at this time despite the weak pace of economic activity," says Mr. Morici. "Inflation continues to be a threat."

In fact, the headline numbers – which include food and energy costs – could be significantly higher. Cereal, meat, and poultry are rising in price, reflecting higher prices for corn, which is also used to make ethanol, a gasoline additive. Gasoline prices, which have dropped a bit in the past two weeks, are still averaging $3.09 a gallon nationally.

The consumer might begin to feel the pressure of rising prices, says Eugenio Aleman, a senior economist at Wells Fargo Banks in Minneapolis. "If the consumer slows down in the second and third quarter, that will reduce some pressure on inflation," reasons the economist. "They could be a helping hand for the Fed."

For the past several years, US borrowers have also gotten a hand from foreign investors. For example, in 2004, net capital inflow (funding from foreign investors) exceeded $400 billion, about as high as the budget deficit. "Foreigners paid for all that debt," says Mr. DeKaser. "But that's not happening so much anymore."

Instead of concentrating on US dollars, many foreign central banks are starting to diversify their foreign-exchange holdings with "baskets" of currencies such as euros, pounds, and Australian dollars. "Foreign capital flows appear to be waning somewhat," says DeKaser. "If there are fewer buyers, our rates will have to rise to attract foreign capital."

Rising interest rates will not help the beleaguered housing industry. Thirty-year fixed-rate mortgage rates are now up to about 6.53 percent, after being at 5.25 percent in mid-2003. Last week, the National Association of Realtors (NAR) predicted they would rise to about 6.6 percent and remain at that approximate level in 2008.

Last month, sales of new homes rebounded. But this was mainly because builders gave large discounts. "Rising interest rates reduce the likelihood we are going to hit the bottom anytime soon," DeKaser says.

Last week, the NAR also predicted that median prices for existing homes would fall this year by about 1.3 percent to $219,100, before rising 1.7 percent next year.

Rising long-term interest rates could also have an impact on the US Treasury. The total US debt is now close to $9 trillion. The resulting net interest is estimated at $260 billion in the upcoming federal budget for fiscal year 2008. The Congressional Budget Office estimates that the 10-year Treasury note will be at 5 percent for next year. But it closed on Friday at 5.12 percent after moving as high as 5.25 percent in wild trading.

"With interest rates rising, it's going to be more than planned for earlier," says Stanley Collender, a managing director of Qorvis Communications in Washington and a budget expert.

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