US Treasury yields rise. Will economy follow?

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    The average rate for 30-year mortgage rates has risen to 5.59 percent this week.
    AP/Charles Krupa
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Interest rates are rising. Do they signal an economic rebound?

That's the debate now unfolding as economists keep a wary eye on US Treasury yields. On Thursday, for the second day in a row, the yield on 10-year Treasury bonds reached 4 percent before falling back. The last time rates were that high was October 2008.

Their rise may portend good news for the economy. Rates typically rise when economic activity strengthens. The rise has also narrowed the gap between three-month Treasury bills and the rate at which banks lend to each other to below half of a percentage point. That suggests "improving health in the banking sector," says the Kiplinger Recovery Index. Interest rate spreads are the only one of six economic indicators that has turned positive so far.

But this recession has not been typical. Some analysts argue that yields are rising because investors are worried about inflation fueled by the surge in US government spending.

That debate is heating up. Some commentators argue that both sides are wrong, because interest rates don't signal things the way they used to. John Carney of Clusterstock writes:

We’ve broken the credit markets. Where once we could learn a lot about investor sentiment and expectations from the credit markets—including the markets for treasuries—the signaling function now is by and large useless. That’s because there are now way too many debt instruments that are the functional equivalent of treasuries.... Every large, complex, systemically important financial institution is a government sponsored entity these days. Why buy Treasuries when you get a better return from bank debt that is just as safe?

So we probably won't know for some time who's right.

The effects, however, are already being felt. The average rate for 30-year mortgage rates has risen to 5.59 percent this week, their highest level since November, according to a release Thursday by Freddie Mac, a government entity that backs mortgage loans.

Higher loans are already choking off mortgage refinancings. If rates go too high, the housing market could tank, too.

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