BUSINESS
07/08/2013 01:30 pm ET Updated Jul 10, 2013

Fed Puts Economy At Risk By Letting Interest Rates Soar

Ben Bernanke could stand to take some advice from Ricky Roma: You never open your mouth until you know what the shot is.

Roma, the smooth-talking salesman in David Mamet's play "Glengarry Glen Ross," was warning against saying too much when trying to hustle an unsuspecting victim. The same principle applies to the Federal Reserve -- which has accidentally stepped on its own bid to hustle the economy by saying too much and causing interest rates to skyrocket.

Borrowing costs have jumped in historic fashion since May, when Fed Chairman Bernanke and other Fed officials started talking about how they could "taper" their program to buy bonds and keep interest rates low to help the economy. I am no Nobel Prize-winning economist, but letting interest rates soar seems to defeat the Fed's purpose of keeping interest rates low to help the economy, no?

Most experts believe the economy can withstand the jump in rates -- which are still relatively low, after all. But then, it is doubtful that the Fed meant to see the rates increase so quickly.

"The 65 percent increase in the 10-year bond yield over the past month and a half is not in any Fed econometric model," Peter Boockvar, portfolio manager at Morgan Stanley's Excelsior Wealth Management, told CNBC on Monday. The Fed, Boockvar said, is on the brink of losing credibility and control of the bond market -- both bad omens for the broader economy.

In fact, the bond market's massacre has been historic, with a record outflow from bond mutual funds in the last week of June and the biggest jump in interest rates in decades. Interest rates move higher when bond prices fall. And they have fallen hard, making suckers out of so-called bond gurus.

The yield on the 10-year Treasury note, which influences other borrowing costs in the economy, particularly mortgage rates, has jumped by a full percentage point in a little over a month -- from about 1.6 percent to about 2.6 percent. The rate on a 30-year, fixed-rate mortgage has gone from about 3.3 percent to about 4.6 percent in that time, according to the Mortgage Bankers Association. That percentage is the highest since October 2011.

The Fed claims that it just wanted to be open and honest with the market about its plans: If the economy keeps improving, then the Fed will taper bond purchases. But if the economy doesn't improve, then it won't taper.

But sometimes you can be too open and honest, especially when you are dealing with financial markets, and especially when you are trying to con the economy into improving. The Fed apparently hoped that the market would understand that its plan to step back depends on whether the economy is strong enough to handle it. But the market is a future-discounting machine, so it went ahead and priced in the Fed stepping back, not caring whether the economy can handle it or not.

Ironically, the market's moves could slow down the economy enough to make the market's prediction wrong, by hurting the economy so much that the Fed realizes it can't taper its bond purchases yet.

Most economists doubt higher rates will kill the recovery. Even after the latest surge in rates, borrowing costs are still near historic lows. The stock market has apparently given up worrying about it, rebounding recently after an initial swoon when Bernanke & Co. first started talking about tapering.

But the surge in rates doesn't help, particularly with Congress and the White House already working against the economy by squeezing government spending and hiring. And the Fed is clearly disturbed by the rise in rates, as it's been trying to talk the markets off the ledge in recent weeks. Bernanke will get another chance to preach calm in a speech scheduled for Wednesday.

The economy is still on shaky ground, growing at a just 1.8 percent annualized rate in the first quarter and possibly at an even lower 1 percent rate in the second quarter, according to some estimates. Job growth has been decent, but the unemployment rate is still at 7.6 percent -- well above the 7-percent mark Bernanke has suggested might mean the end of the Fed's bond-buying program.

Rising interest rates directly challenge one of the brighter spots in the economy lately: the housing market. Mortgage applications tumbled 12 percent last week from the week before, according to the Mortgage Bankers Association.

The good news is that most of that decline was in applications for refinancing, while purchase applications haven't fallen all that much. This means either that interest rates are still close enough to historic lows to encourage buyers, or it could mean that potential buyers are scrambling to lock in low rates while they still can.

Only time will tell for sure. Unfortunately, because the Fed opened its mouth, we no longer have the luxury of time.

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