If These Big-Name Investors Are Right, Brace for Rising Rates

Warren Buffett
Warren Buffett

Plenty of questions remain about the strength of the economic recovery even as investor optimism soars. Extremely upbeat data -- for example, like the Wednesday ADP private-sector jobs report -- need to be taken with at least a grain of salt.

But investors should nonetheless pay attention to the spate of highly influential pros who seem to agree on at least one point: Interest rates should be heading up next year. And that's likely to have an impact across financial markets -- particularly on those so-called safe haven investments, U.S. government bonds with long maturities and gold.

Who are some of the big-name investors who now seem to be anticipating higher interest rates? Warren Buffett, for one. His Berkshire Hathway (BRK.A)sold $1.5 billion in new, mostly fixed-rate debt in order to retire floating-rate notes this week.

Characteristic Good Timing

Moves to lock in interest rates by investors like Buffett (pictured) who are known for their consistent savvy should be watched closely. Recall that investment bank Goldman Sachs (GS) was able to take advantage of overly generous bond markets at the end of October when it issued $1.25 billion worth of bonds with a staggering 50-year maturity at a yield of just 6.125%.

Goldman's move seems to have been characteristically well-timed, with the yield on the benchmark 10-year Treasury bond -- which moves in the opposite direction as the price -- shooting up sharply starting at the beginning of November.

Now, Goldman forecasts 10-year yields climbing substantially to 3.75% by the year-end – well ahead of the 3.52% predicted by a Bloomberg analyst survey. Goldman sees the yield reaching 4.25% at the close of 2012.

A Higher Dollar and Lower Gold?

Other pros see even sharper rises ahead. Veteran investor Byron Wien of investment powerhouse Blackstone (BX)predicts in his list of potential surprises for 2011that 10-year yields could approach 5%.

The prospect of sharply rising yields would have broad consequences. The dollar could rally further as currency traders anticipate interest rate differentials with the euro. Even as the U.S. recovery gains steam, the greenback's main currency rival continues to struggle with banking sector issues.

A rising dollar amid growing optimism could hit commodity prices, especially gold. In fact, the precious metal saw a sharp sell-off this week and has traded down for the past three days amid better-than-expected economic reports.

"If the Optimists Are Right. . ."

The impact for stocks remains less clear. While rising rates are usually a headwind, they're still low by historical standards. And a deflationary panic as opposed to inflation was the markets' most recent dominating fear.

Much will depend on whether rising rates are driven by anticipation of U.S. growth or concern's about the country's credit quality, as some commentators have attributed recent upticks to.

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"If the optimists are right, and if any rise in U.S. bond yields continued because of a return to normality, then in fact, the dollar might rise, corporate bond spreads certainly tighten, and the stock market rally, possibly significantly," Jim O'Neill, the chairman of Goldman Sachs Asset Management wrote in December.

So far, the evidence supports the bulls. Despite all the talk of creditors bailing on U.S. debt, the cost of credit default swaps to insure U.S. debt have fallen meaningfully during the last months of 2010 even as yields rose.

It can be tough for investors to see the big picture through Wall Street's daily lurches and a frenetic financial media. Rising interest rates amid an economic recovery, though, is one of the few things that a growing number of investors seem to agree on.

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