An Unwise Rise

By Daniel Kadlec

Interest rates are on the rise, and if you are holding a variable-rate loan or need to borrow now, you may well ask why. You will not be happy with the answer. Wall Street, of course, is ground zero, but don't go looking for logic there. All you'll find is a bunch of paranoid bond traders with more worries than a Woody Allen character. It is these traders who have decided that the prices you pay for gas, Wheaties and SUVs are about to start shooting higher, and so they are selling bonds--driving up bond yields--in what amounts to a demand that they get paid more while inflation rages.

It doesn't take a wing-tipped M.B.A. to spot the flaw here--much of the world is in or near recession, demand for personal computers is slowing, so are corporate profits. Amid that sluggishness, the Labor Department said Friday that unemployment inched higher in February--to 4.4%, from 4.3% the previous month. And the prices of raw materials like oil and copper, on average, are at their lowest in decades. This is not the stuff of sudden price hikes in consumer items. "It's beyond me how anyone can be worried about inflation," economist Allen Sinai at Primark Decision Economics says flatly. So exactly what do these masters of the universe discern?

Well, Fed chief Alan Greenspan, who had been leaning toward an interest-rate cut, now says he's no longer leaning. His next move could be up, could be down. That probably means no move is forthcoming--hardly a reason to panic.

Employment and consumer confidence remain robust, and the economy should turn in a solid year of 2.5% to 3.5% growth, Sinai notes. As we've been hearing (but not seeing) for much of the '90s, sustained growth leads to rising wages, which lead to higher prices and, ultimately, higher interest rates. For the umpteenth time, bond traders say we have reached the point at which all that nastiness commences. But they're really just reading tea leaves, projecting what is famously difficult to project. For inflation to take off, Japan and the rest of Asia will have to wake from a deep sleep before Europe or the U.S. starts to nod off. Interest rates in Japan, by the way, dropped to near zero last week. Inflation? The government is prodding people to buy something, anything, to keep prices from sinking. Even if there is a global recovery, competition aided by technology advances will serve as the price police.

In short, 30-year Treasury-bond yields spiked as high as 5.69% last Thursday, from 5.08% at the end of January, because some bond traders think--yet again--they just might see a possible uptick in inflation at some point in the undefinable future. Might happen. Might not. I view this skittishness as merely the latest pendulum swing in Wall Street's obsession with inflation. It will swing the other way soon enough. In fact, the T-bond yield fell to 5.59% Friday. Still, we have to live with bond traders' anxieties, and for now that means higher mortgage and other rates.

What can you do? Rates may be near a peak. If so, this is a good time to put any sideline cash into stocks or bonds, both of which will benefit if rates stabilize or head lower. If you can put off borrowing money, do so. If not, the risk is that rates keep moving up, in which case stocks and bonds are vulnerable and your loan gets even more expensive. Rising rates smack growth stocks the hardest. So one hedge is to shift from stocks that typically trade at 30 to 70 times earnings (many tech stocks) to value stocks trading at far lower multiples. Those include small companies and dividend payers like utilities and real estate investment trusts. Then wait out the fever.

See time.com/personal for more on rising rates. E-mail Dan at kadlec@time.com See him Tuesdays on CNNfn at 12:45 p.m. E.T.