Tuesday, June 12, 2007

Interest Rate Sell Off

Stocks are selling off as the yield on the 10-year note climbs. At last look, it's standing at 5.26%. Just a couple of months ago, it was down around 4.5%. My expectation that interest rates would rise was one reason I cited for my bearishness on stocks in the June 18 issue of Forbes magazine.

Many economists have been betting that the Fed would cut short-term interest rates. I've been saying that what the Fed does is largely irrelevant. The yield on the 10-year note is much more important. I believe the Fed was hoping that the 10-year yield would rise so it would not have to raise short-term rates anymore. Now that it has, the Fed can breathe more easily.

The Fed's next opportunity to change rates comes on June 28. Now that the yield curve is cooperating with its wishes, my guess is that the Fed will take no action. The higher 10-year yield will keep a lid on inflation by keeping the economy from overheating. The bigger risk right now is too much of an economic slowdown.