Interest rate increase

The media is abuzz with the news of an interest rate increase. Why are rates rising and what are the primary effects of rising rates? Rates are not rising because of some new Fed policy. To the contrary, rates are rising in spite of relatively constant (and peculiar) Fed policy. Rates are rising because the rate of return in the economy is rising. A recovery is finally underway. By the way, the first true indicator of this was the recent improvement in the housing market. This is quite typical of recoveries from recessions . . . the housing market responds first.

The primary effect of a rise in interest rates is that the value of most bonds or stocks that act like bonds (like utilities that pay constant dividends) will decline. The finance term that relates to this effect is “duration.” Duration refers to the sensitivity of asset value to a change in interest rates. Positive duration is when an increase in rates causes a decrease in values. The larger the duration, the larger the decline in value with a given increase in rates. Bonds with longer terms will have larger duration.