Don't be a bond Chicken LittleAugust 15, 2013: 1:09 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.
Interest rates are going up! Interest rates are going up! It's the bond market equivalent of Chicken Little screaming that the sky is falling.
Now, to be fair to fixed-income wonks, it is in fact true that interest rates are going up. Chicken Little, on the other hand, came to an erroneous conclusion due to her ignorance of the fundamental laws of gravity. (Watch out for that acorn next time! Plonk!)
But investors, just like Chicken Little, do need to take a deep breath and relax.
Yes, the yield on the 10-year Treasury rose to 2.82% Thursday morning. And that's not just a 52-week high. Rates haven't been at this level since July 2011. You don't need to be a Mathlete (like I was back in the proverbial day ... once a nerd, always a nerd) to figure out that this is pretty darn close to the psychologically important level of 3%.
But is this a problem? No.
Take the long view (but not the long way home ... yes I just dropped some Supertramp on you. Guilty pleasure!) The 10-year yield was 4% just as the Great Recession was about to begin in December 2007. And rates were routinely above 4% throughout 2005 and 2006 -- sometimes even topping 5%.
That didn't derail the housing boom in those years. So why should rates below 3% put an end to the housing recovery?
Bond yields appear to be rising for two related reasons. The economy is slowly but surely getting better. That's led to increased speculation that the Federal Reserve will finally begin to rein in its quantitative easing program ... possibly as soon as next month.
If the Fed pulls back, or tapers, its $85 billion a month in bond purchases, yields should creep higher. Bond yields go up when prices go down. Prices go down when people, or in this case, Fed worker bees, aren't buying as many bonds.
So the second reason bond yields have shot up lately is because Wall Street is all about trying to predict the future. They are getting ahead of the beginning of the end of QE by selling bonds now. That drives rates higher.
It's also worth noting -- even though the data is not completely up-to-date -- that both China and Japan reduced their holdings in U.S. debt in June. The Treasury Department released that information Thursday morning. China and Japan collectively owned $2.36 trillion in Treasury securities. That's down from $2.4 trillion in May.
If China and Japan continue to sell, rates should head higher. And why shouldn't they unload more Treasuries? It's probably smart of them to diversify their holdings. And amazingly enough, Europe may be attractive again with the eurozone finally out of recession.
Finally -- and I can't stress this point enough -- panicking about interest rates going from 1.6% in May to 2.8% doesn't make sense because rates never should have been as low as 1.6% in the first place.
Investors got complacent. They really started to believe that the economy would never recover and that we would all live happily ever after in a QE ∞ world where magical Fed fairies sprinkle the pixie dust of more bond purchases to keep rates "exceptionally low" indefinitely.
That all changed in May when Fed chair Ben Bernanke first hinted that tapering could soon be on the way.
Now, I have criticized the Fed -- and Bernanke in particular -- for talking too much lately and confusing the market. But all Fed members have been pretty consistent during the past few months. They all say that the Fed will only taper if the job market improves.
The job market is improving. Payroll growth may not be as robust as we'd like. But initial unemployment claims are back at pre-recession levels.
The sky isn't falling. And that's why bond yields shouldn't be falling either. It's time to not just recognize that fact, but also celebrate that rising rates are a sign of a healthier economy.