How Rising Interest Rates May Affect ETFs and the Economy

June 5th at 3:00pm by Tom Lydon

The recent strength of the stock market and exchange traded funds (ETFs) has come with a price: rising interest rates.  But how exactly will this affect the overall health of the economy?

Several economists believe that a rise in interest rates could potentially undo the recovery of corporate profits and the housing sector, two areas that equity investors have been banking on as they bid stock prices higher.  This could potentially be detrimental and send the markets in another downward spiral.

To add fuel to the fire, a surge in interest rates makes it harder for individuals to obtain mortgages and fattens up an already outrageous amount of debt held by the federal government, adding costs to the taxpayer.

Now that we know the effects of a hike in interest rates, what exactly is causing it?  Michael Cosgrove, a Dallas economist, suggests that interest rates are rising because the fear factor in the global economy is starting to fade. There is also a huge supply of Treasury debt that is coming to the market, reports Mark Trumbull of the Christian Science Monitor.

The concept is fairly simple.  As investors become more confident in the stock market, they buy up more equity and less government debt.  This causes government borrowing rates to increase.

Most recently, the interest rates on a 10-year Treasury note have shot up from 2.93% in April to 3.68% on June 1 and yields on Treasuries continue to edge upward. As a result, some prominent investors have gone as far as to say that the Treasury market is in a bubble and will soon burst.

  • iShares Barclays 7-10 Yr US Treasury ETF (IEF): down 7.9% for the year and has a yield of 3.8%

  • Vanguard Extended Dur Trsy Idx ETF (EDV): down 35.8% for the year and has a yield of 3.9%

Kevin Grewal contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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