How higher rates touch consumers, firms, investors

By CHRISTOPHER S. RUGABER
AP Economics Writer

WASHINGTON (AP) -- All it took was speculation that the Federal Reserve could slow its bond buying months from now -- and then a few words Wednesday from Chairman Ben Bernanke to confirm it.

The result is that record-low interest rates that have fueled economic growth, cheered the stock market, shrunk mortgage rates but punished savers are headed up.

Suddenly, long-term borrowing rates, though still historically low, are rising. And once the Fed starts scaling back its bond purchases, those trends could accelerate. It means home loans are starting to cost more. Corporations will pay more to borrow. Bond investors are being squeezed. The stock market is plunging.

The yield on the 10-year Treasury note, a benchmark for long-term mortgage rates and other loans, hit 2.43 percent Thursday. As recently, as May 3, it was 1.63 percent.

For now, mortgage rates remain extremely low by historical standards. Economists say rates might not rise much further unless the economy strengthens significantly.

And the fact that Bernanke and the Fed think the economy is healthier represents a critical dose of confidence. Slightly higher rates may spook stock and bond traders. But in the long run, a robust economy should sustain the housing rebound, support job growth and encourage businesses to borrow, even at somewhat higher rates. More economic growth should ultimately boost stock prices, too. Long-term investors saving for retirement, college educations and other major costs stand to benefit.

The Fed's $85 billion-a-month in bond purchases have helped keep long-term rates down. Bernanke said he expects the Fed to stop buying bonds altogether by the middle of 2014 if it feels the economy can manage without that stimulus. He stressed, though, that if the economy weakens, the Fed won't hesitate to step up its bond purchases again.

Here's how higher rates will affect consumers, businesses, investors and other players.

CONSUMERS

The main impact on consumers will be higher mortgage rates, economists said. Rates on auto loans, student loans and credit cards probably won't change much soon. They're more closely tied to the short-term rate the Fed controls. That rate isn't expected to rise before 2015.

The average rate on a 30-year mortgage jumped from a record low of 3.31 percent in November to 3.98 percent last week, according to mortgage giant Freddie Mac. That's the highest level in more than a year.

Mortgage applications fell 3.3 percent last week, according to the Mortgage Bankers Association, though applications are still up from their level a year ago.

But economists say the housing recovery can withstand higher rates. Sales of existing homes topped 5 million in May for the first time in 3{ years.

Steady job gains, modest economic growth and greater consumer confidence should fuel sales in the coming months, even if rates are higher.

"It's that improving economy that's bringing people back into the housing market," said Greg McBride, senior financial analyst at Bankrate.com. "The recent rise in mortgage rates does not negate that."

The biggest barrier for many home buyers has been difficulty obtaining a mortgage. Banks have tightened their lending standards since the financial crisis erupted in 2008. Higher rates would allow banks to make more money on mortgage lending and could lead them to lend more freely.

"The irony is that higher rates are likely to mean more people can get mortgages," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank.

SAVERS

Higher interest rates generally benefit those with much of their money in savings. They can earn more on bond investments, CDs and savings accounts.

But savers aren't likely to see much benefit anytime soon. Banks already have a lot of deposits, McBride said, and don't need to ramp up the rates they offer on CDs or bank accounts to attract more cash.

"They're having trouble lending out the deposits they have," he said.

Rates on the 10-year bond, for example, are still pretty low and may not outpace inflation over the next decade. A 10-year Treasury bond yielding 2.4 percent "is still a bad deal," McBride said. "You'll be lucky if you keep pace with inflation."

BOND INVESTORS

Ordinary investors who have soured on stocks have poured about $1 trillion into bond funds since the Great Recession. A common assumption is that bonds aren't very risky. These investors might be having second thoughts.

That's because as rates rise, bond investors can lose principal as the value of their existing bonds declines. Investors in bond funds, especially those with long-term holdings, are most at risk. The Pimco Total Return fund, the world's largest mutual fund with $285 billion in assets, has lost 3.3 percent in the past month.

Marilyn Cohen, president of Envision Capital, fears that baby boomers will pull out of bond funds as fast as they rushed into them. If so, that could send bond prices falling further in a vicious cycle of selling spurring more selling.

"The group that stampeded out of stocks into bond funds is going to have a challenging year," she said.

Another worry is big losses at funds that have borrowed heavily to buy bonds. Using borrowed funds to invest can magnify losses. The BlackRock MuniHoldings California Quality Fund has borrowed the equivalent of 42 percent of its assets, according to Morningstar, a fund research firm. The fund has fallen 11 percent the past month.

HOME BUILDERS

Higher mortgage rates could lower demand for new homes. That would squeeze homebuilders. The share prices of leading builders like Toll Brothers, Lennar and D.R. Horton all plunged Thursday far more than the stock market as a whole.

But many builders say they remain optimistic. They think higher rates will encourage potential buyers to get into the market before rates rise further.

"We're trying to encourage buyers to get off the fence, so we think it will actually help sales," said Holly Haener, director of sales and marketing at CBH Homes in Meridian, Ohio.

Eventually, if mortgage rates keep rising, some buyers would no longer be able to afford a home, Haener acknowledges. They might have to buy a smaller house or forgo some home amenities to offset the cost of a higher loan rate.

SMALL BUSINESSES

Higher rates may further depress loan demand at many small businesses, at least for the short term.

But higher rates can also benefit small business because they signal that the economy is strengthening. When companies start making more money because they have more customers, they're more inclined to expand or buy equipment even though financing is costlier.

Bella Bag, a retailer of previously owned designer handbags and other accessories based in Atlanta, is getting the first loan in its eight-year history. Chief financial officer Brian Froehling said the company decided to borrow now because it thinks rates will rise.

Higher rates might give Bella Bag pause before it borrows again, Froehling said. But the company has hired four staffers this year in response to growing demand. It will likely do well even if rates rise further, he said.

BIG BUSINESSES

Large U.S. companies have sold a huge amount of bonds to investors in the past 2{ years -- more than $4 trillion worth, according to Dealogic, a research firm. That's more than the economies of every country in the world except the United States, China and Japan.

The biggest sale ever was Apple's offering of $17 billion in bonds in April.

But as rates began rising last month, new sales are slowing. Companies with top credit ratings sold only $9.5 billion in bonds last week, according to Dealogic. That's 60 percent less than the average for each week through April this year.

Still, companies have been collecting record profits. That means they should still be able to expand their businesses and hire more, even if borrowing costs rise.

AP Business Writers Bernard Condon and Joyce Rosenberg in New York, Alex Veiga in Los Angeles and Martin Crutsinger in Washington contributed to this report.