Washington Post
January 4, 2006

Inverted yield curve on interest rates may lead to re-evaluating financial strategies
By EILEEN ALT POWELL
AP Business Writer


NEW YORK (AP) -- The yield curve turned upside down in late December, leading some financial experts to suggest that consumers need to re-evaluate their saving and borrowing strategies in the new year.

Normally, long-term interest rates are higher than short-term rates because it's hard to predict what will happen far out in the future. But on Dec. 27, for the first time in five years, the yield curve "inverted" when the rate on 10-year Treasury securities dipped below the rate on two-year Treasury securities.

This has obvious implications for people who invest in Treasuries. They have to be asking, Why should I tie up my money for a decade when I can get a better return investing it for just two years?

There are also ramifications for consumers who are making saving and borrowing decisions, and they could persist well into 2006 if the Federal Reserve continues pushing up short-term rates to keep inflation in check while long-term rates hold steady.

Savers will find solid returns on short-term certificates of deposit, money market deposit accounts, money market mutual funds and high-yielding online savings accounts, McBride said.

One-year CDs are paying an average annual yield of 3.28 percent nationwide, according to Bankrate.com, and savers who invest in them will be able to roll their money into higher-yielding accounts when the CDs mature. A saver who ties up money in a five-year CD will get only a little more, 3.92 percent, and won't be able to take advantage of rising rates.

Borrowers, meanwhile, will benefit from locking in today's relative low long-term rates, and from selecting fixed-rate loans over adjustable-rate loans.

Michael L. Moskowitz, president of mortgage lender Equity Now in New York, said that "fixed-rate mortgages, which are following the 10-year Treasury bond, are an outstanding value now."

According to the latest Mortgage Bankers Association survey, the rate on 30-year, fixed-rate mortgages fell to 6.15 percent for the week ending Dec. 30 from 6.21 percent a week earlier. Meanwhile, the rate on one-year adjustable rate mortgages - which are tied to short-term securities - rose to 5.41 percent from 5.36 percent. Home buyers who select the adjustable-rate loans likely will face rising rates in coming years.

Moskowitz said homeowners who have hybrid mortgages, including those with a fixed rate for three years or five years and then an adjustable rate, need to look at their current situation before deciding whether to refinance into a fixed-rate mortgage.

"If you're facing a rate adjustment in the next six to 12 months, then by all means look at the fixed-rate mortgages," Moskowitz said. "But if you have 3 1/2 years to go, I think you should have some discipline and take a chance on holding it."

The inverted yield curve will also affect how people borrow against their homes.

"The cat is now out of the bag" on home equity lines of credit, on which rates have risen in lockstep with Federal Reserve increases, Moskowitz said.

In some cases, the rates on home equity lines of credit are now a percentage point or more above the rates on home equity loans, so homeowners may want to shift to the fixed-rate home equity loans, Moskowitz said.

While consumers may make some short-term savings and borrowing decisions based on the yield curve, they shouldn't let it dictate their long-term strategies, said Dave Yeske, a certified financial planner in San Francisco.

Everyone should have liquid reserves, like an emergency fund, he said, and these savers can take advantage of higher rates in short-term accounts.

"But most people also have long-term goals - the stuff you're setting aside to pay for college for a 6-year-old or so you can retire - and you shouldn't have all that much in short-term, fixed-income investments," he said.

That means developing a financial plan, saving regularly, selecting diverse investments such as large-company and small-company stocks, periodically rebalancing the holdings and sticking to it for the long term.

"Then you're done," he said. "And headlines about yield curves and things like that are meaningless to you. They're just noise."