The S&P 500 is up 11% year-to-date. But there is another rally that is getting less attention: U.S. Treasury yields have been on the rise.
Short-term Treasury yields have inched up throughout 2012, while longer-term Treasuries have bumped up only in recent weeks.
Of course, interest rates are still well below where they were before the financial crisis. At the start of 2008, the 10-year Treasury yield was 3.9%, compared with 2.25% today.
Interest rates have been on a downward slide for nearly five years. The most significant descent started in 2008 when the Federal Reserve cut the federal funds rate to effectively zero. In fact, rates have been low for such a long time, borrowers have gotten a bit complacent.
There has been little urgency to borrow at low rates because, up until now, there has been no penalty for waiting. To some extent, a little bump in rates might do more good than harm to the economy. For example, the threat of even slightly higher mortgage rates might do a lot to get potential home buyers off the sidelines. Likewise, corporations might decide to borrow more now, locking in low rates before they rise.
Of course, the rise in rates may be a short-term phenomenon. Hedge-fund managers, however, are betting that it is the start of a bona fide trend. Believing yields might go even higher, hedge funds and other large investors sold 78% of their holdings of two-year Treasury futures the week ended March 13, according to a Bank of America/Merrill Lynch report. The same report noted that big money managers tripled their short positions against 10-year Treasuries.
Banks: Banks will still be able to borrow money at rock-bottom rates, but may be able to issue new home, consumer, and corporate loans at higher rates. In my February issue of The Daily Paycheck, I profiled First Financial Bancorp (Nasdaq: FFBC), a regional bank that may be a beneficiary.
Floating rate securities: The interest rate for floating rate -- or adjustable rate -- debt is determined by short-term lending rates. A rise in short-term rates generates more income for floating rate securities.
Floating rate funds like BlackRock Floating Rate Income (NYSE: BGT) should benefit if short-term interest rates continue to creep up. Since the bottom of the sell-off in October of last year, this fund's price is up 18% -- a strong move for a steady bond fund yielding almost 7%.
Savings accounts and employment services companies: If you have money in a savings account, then you've probably noticed that it is yielding just a little bit more than if you had stuck it under your mattress. If this interest rate trend takes hold, then you might see a tiny bit more yield from your savings account. But for employment companies such as Paychex (Nasdaq: PAYX), a little incremental yield goes a long way.
Paychex makes interest income on the money it holds for its clients until the money is used to pay employees, fund retirement accounts and so forth. If the employment situation continues to improve and interest rates rise, then that's a double bonus for employment services companies.
Risks to Consider: On the flipside, there are a couple of areas I'd avoid if rates rise.
Specifically, callable fixed-income bonds are being called frequently as companies redeem the bonds to issue cheaper debt before rates rise. And mortgage real estate investment trusts (REITs) like Annaly (NYSE: NLY) are facing headwinds too. In the short term, higher mortgage rates will likely trigger a new wave of mortgage refinancing (to take advantage before rates rise too far), which will be a drag on their business.
Action to Take --> It is still too early to say whether this recent lift in interest rates is a trend or a flash in the pan. Surprisingly bad economic news out of China or another debt emergency in Europe could cause investors to find their way back to the relative safety of Treasuries -- driving the yields back down. But I always want you to be prepared for any change in the market. And this is something I'm going to continue to focus on.