Rates are headed higher but they’re still low

Friday's jobs report doesn't signal the end of the Federal Reserve's market-friendly bond-buying program, but perhaps the beginning of the end. But life will go on, and probably quite well.

The Friday jobs report showed that the nation added 203,000 jobs in November, comfortably ahead of the 180,000 expected by economists. The unemployment rate fell to 7%, and the labor force rose by the largest amount in 30 years.

And that's all good news. As more people become employed, they have more to spend, which, in turn, boosts demand for business's goods and services.

Not surprisingly, bond yields rose on the news. Bond yields represent the demand for money: As the economy heats up, the cost of money rises.

What does this mean for investors? First, it means that the time of Fed tapering -- dialing back on its massive monthly bond purchases -- is probably nearing. It's not here yet. The Fed may well wait until Congress and the president agree on the budget. And the total labor participation rate is still a low 69%.

Nevertheless, normal long-term interest rates are considerably higher than where they are now. The 10-year Treasury note has averaged 6.6% since 1962. If, eventually, the Fed stops buying long-term bonds, long-term interest rates should rise toward their long-term average. That has several implications for investors:

• Bond prices will fall. When interest rates rise, bond prices fall. If you own a bond that yields 2.5%, you'll have a hard time selling it when newly issued bonds yield 3%. To sell the bond, you'll have to take a cut in price. If you own a bond fund, you'll feel that: Interest payments from the funds' holdings won't be enough to offset price declines.

• Bond yields will rise. If you're looking for income, this might be time to consider a bond ladder: Buying individual bonds or bank CDs at periodic intervals. As each bond or CD rises, you'll be able to reinvest at higher interest rates. Fidelity Investments and T. Rowe Price both offer CD ladde! rs for investors, if you don't want to do it yourself.

• Stocks may have a mild tantrum when it senses that the Fed is tapering. But stock prices essentially follow anticipated earnings, and earnings expectations should rise as unemployment falls and the economy grows. A 3% yield on the 10-year Treasury note is still historically low.

Friday's jobs report number isn't enough for the Fed to taper, and certainly not enough for it to nudge up its key short-term fed funds rate. But it is enough for investors to start thinking about a world where long-term interest rates are moving closer to normal.

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