When Interest Rates Head Up
It doesn't take any skill at prognostication to make this forecast: Interest rates are heading up. For one thing, they can't go any lower.
Whether you think rising interest rates is good or bad mainly depends on whether you're a borrower or a lender. If you run a small business that depends on credit to buy raw materials or inventory, then rising interest rates are bad news. If you're a member of the rentier class and live on interest and dividends, then rising rates will be a boost to your income.
Of course, it's an over-simplification to speak of "interest rates" as if they all moved together. There are lots of interest rates, and some of them behave very differently from others. In particular, although we talk about "low" interest rates, there aren't many borrowers who can actually borrow at low rates — just governments and large financial institutions, really. Mortgage rates have been pretty low (for well-qualified borrowers), and some car loan rates have been low as well. Other consumer rates, though, never fell much to speak of. Rates for borrowers with poor credit started high and stayed that way.
Still, whether you think rising interest rates is a good thing or a bad thing, it's sure to happen, so you need to be prepared.
Dealing with rising rates
When rates are rising, the rule is this: borrow long and lend short. Now might be a fine time to lock in a good rate on a 30-year mortgage, but do not get an adjustable-rate mortgage, even if the rate seems like a great deal. Similarly, don't start putting your money into 30-year treasury bonds. (Inflation-adjusted Treasury paper may be an exception.)
When will rates go up? I don't know. Probably even the members of the Federal Reserve Open Market Committee don't know, and they're the folks who decide. At their last meeting they left intact the language that said that rates would stay low for "an extended period." People have been assuming that this means at least 6 months. A couple of members have started talking about the need to get rates back to "normal" levels, but just a day or two ago someone at the San Francisco Fed suggested that near-zero rates might be appropriate until 2012.
I do know this: once rates start going up, they will keep going up for a very long time. To me, that means that locking in rates for the short-term (6 months or even a year) will be harmless. Yes, it will mean that you won't be participating in the higher rates the instant that they go up. But, since rates will keep going up, when your CD (or whatever) rolls over a few months later, you'll get an even higher rate.
My take on it is that you needn't hesitate lock in for as long as year, if you can get a better rate than you can get on cash. But I'd definitely draw the line before 2 years. Once rates start up, rates on 2-year paper will move up sharply. You wouldn't want to have to wait 15 or 20 months to take advantage of that.
Finally, once rates do start moving up, don't be in any hurry to lock in the new higher rates. Interest rate cycles tend to be very long: The current cycle of declining rates has been running for almost 30 years (since 1981). I wouldn't be surprised if, once rates start going up, they kept going up for just as long.
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