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. Last Updated: 07/27/2016

Short-Term Rate Jump May Presage Fed Hike

LOS ANGELES -- A sudden jump in shorter-term market interest rates suggests that the Federal Reserve Board will tighten credit soon, as the U.S. economy continues to expand.

Shorter-term rates, such as on U.S. Treasury bills and notes, would be directly affected by an official Fed rate increase. Until recently, bill and note yields appeared to be stabilizing after surging in early spring.

But over the last two weeks, shorter-term yields have risen markedly, as more investors have apparently become convinced that the economy has enough momentum to warrant tighter credit:

?Three- and six-month T-bill yields reached 5.09 percent and 5.21 percent, respectively, at Monday's weekly Treasury auction, up from 5.03 percent and 5.14 percent a week earlier and the highest since last year.

?The yield on one-year T-bills was 5.76 percent at Tuesday's market close, up nearly a quarter of a percentage point just since May 22. The yield has risen from a low of 4.82 percent in early February, before the economy began to pick up steam.

While many investors pay attention to long-term bond yields -- such as on the 30-year Treasury bond -- longer-term yields are theoretically more sensitive to expectations for inflation than to changes in the Fed's official short-term rates.

The bellwether 30-year T-bond yield, at 7 percent Tuesday, is no higher than it was in early May, suggesting no major change in the inflation outlook. But the steady rise in shorter-term rates since early May signals that more investors are preparing for a Fed rate hike -- just one year after the central bank began lowering rates to stimulate the economy. The Fed's most recent move was to cut its benchmark short-term interest rate, the federal funds rate, to 5.25 percent from 5.5 percent on Jan. 31. But since then the economy's resilience has surprised nearly everyone. And Fed officials in recent weeks have hinted that the time may be drawing near when the central bank must begin raising rates to keep the economy from growing too fast and fueling higher inflation.

Even as shorter-term market rates rise, appearing to anticipate a Fed rate boost, many economists continue to doubt that the central bank will act at its next meeting, which will take place July 2-3.

Indeed, a Reuters poll of 30 economists this week shows 29 of them believe the Fed will stand pat at the July meeting.

"My bet is they don't raise rates" at the next meeting, said Irwin Kellner, economist at Chase Regional Bank in New York.

Kellner argues that the economy's strength has been overstated this year and that consumer spending will run out of steam in the second half of the year because of high debt levels, still-slow income growth and higher mortgage rates. In terms of slowing the economy, "the bond market has done the Fed's job for it already" thanks to higher interest rates, he said.

But Robert Brusca, economist at Nikko Securities in New York, believes that Kellner and others who are counting on a slowing economy are getting it wrong, just as they have been wrong about the economy's strength so far this year.

For now, the issue is how long-term bonds, and the stock market, will react if shorter-term rates continue to rise, betting on a Fed rate hike sometime in the next few months. If the bond market expects that the Fed won't stop at one quarter-point rate increase, bond yields are likely to go higher. And the problem, notes Bank of America Senior Vice President Kirk Hartman, is that "usually when the Fed changes direction, it keeps going" in that direction for a while.