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10-yr Treasury yields (top chart) hit bottom last September (1.72%), and are now 66 bps higher (2.38%). Conforming 30-yr fixed mortgage rates hit bottom last December (3.94%) and are only marginally higher today (4.09%). There's a bit of a lag between the two, and the spread between 10-yr Treasuries and Fannie Mae collateral has compressed to about as tight as it's going to get. So the recent rise in 10-yr Treasury yields will almost surely result in a significant increase in conforming mortgage rates in the weeks and months to come. If the recent rise in Treasury yields holds, then the bottom chart is depicting what will prove to be the all-time low in mortgage rates.
If mortgage rates are headed higher, won't this slow or possibly halt the nascent housing market recovery? No, and here's why:
To begin with, Treasury yields and mortgage rates fell to historically low levels last fall primarily because a) the demand for safe-haven Treasuries and agency mortgages was intense, since the market fully expected the U.S. economy to fall into another recession, and b) the demand for home mortgages was historically weak, because potential homebuyers were fearful that prices would decline further. In short, the intense demand for safe-haven Treasuries and relatively safe mortgages coupled with the very weak demand for home mortgages resulted in a surfeit of loanable funds which, in turn, pushed interest rates to historically low levels.
Today's rising interest rates signal an important reversal in investor psychology and in the prospective health of the economy. Things are getting better, and the demand for safe-haven Treasuries is therefore declining. An improving economy should bolster the demand for mortgages, even as interest rates rise. Rising interest rates go hand in hand with an improving economy; higher interest rates don't weaken the economy, because they are a direct reflection of a stronger economy. Higher rates only become a threat to the economy when they are driven higher by tight monetary policy, but that is manifestly not the case today. Moreover, prospective homebuyers are likely to be encouraged to buy even as rates rise, because they will begin to see that it is better to buy now than to wait for rates to rise even more. At today's prices and even with substantially higher interest rates, housing is more affordable than ever before for the majority of households.
This chart comes from the National Assoc. of Realtors, and shows that a family earning the median income has about twice the amount needed to purchase a median-price home using conventional financing.
20 comments:
aren't the higher treasury yields bad news for the us govt?
Good question, but there is no clear answer. Higher interest rates will definitely increase federal debt servicing costs, and outstanding federal debt is gigantic and likely to increase by at least $1 trillion this year. But to the extent that higher interest rates reflect a healthier economy, then the outlook for federal revenues improves at the same time that debt service costs rise. A stronger economy will have more workers earning more income and paying more taxes. Tough to say which of these will win out in the end.
But let's say that the combination of these two forces will likely add to the federal government's financing burden (i.e., debt service costs will rise by more than the increase in tax revenues). I would argue that if this is the case, then that will add up to a powerful argument to reduce government spending. In the end, a reduction in spending in both nominal and relative terms (relative to GDP) would provide a real boost to growth, and that could be much more important than rising debt service costs.
In other words, I do believe there is a growth-oriented solution to our current and potentially precarious fiscal mess.
The average maturity of the U.S. debt
is around 5 years...Average interest
rate is 2.3%....call when the 5 year
starts to auction at 3% or higher
Yields are still so low, who cares. The Fed really needs to aggressive spur growth, probably through another QE program--although this is erroneously reported and then understood as a signal "the economy is weak."
Prosperity is what the USA needs, a good long boom, without too much borrowing.
The federal government needs to cut back agency spending and trim entitlements, while the Fed promotes growth by any means necessary.
After a real estate bust and in a deep recession is not the time to fret about inflation. Precisely the opposite.
"If mortgage rates are headed higher, won't this slow or possibly halt the nascent housing market recovery? No,"
I would agree with the above, in a normal recovery cycle, but this one is tepid at best..
Hans-
People will buy real estate if they think the bottom has been reached. Sheesh, people were buying real estate like hotcakes in the 1980s at double digit interest rates.
There could be an outright explosion on the upside n current real estate.
We are very close to a large, sustained secular bull market in equities and property. Maybe a Romney Presidency, or some other positive (sensible federal budget, aggressive Fed) will do the trick.
Anyone been noticing even the Federal Funds rate has knocked upward lately? Would be *really* interesting to see what would happen if it started bumping up against the FOMC's 0.25% target.
Federal Funds Rate
Short write-up with chart
Plus an interesting write-up in the WSJ here.
Unknown:
I wish people would drag out some charts of inflation and interest rates going back to the 1960s.
Inflation and interest rates are just way, way low today. Dead.
A bump up here to there hardly matters.
I can remember when the WSJ told Volcker he was being too tight and that since 5 percent inflation had been reached (an improvement from double digits), it was time to loosen up. True story. 1984.
Now we get hysteria when inflation looks like it might---might---go above 2 percent. Sheesh.
Get a grip guys. Can we have some boom times first, and then worry about 3 percent inflation?
Reality check -- higher interest rates are bad for business, but good for monetary policy, and the two are not synonymous -- let's not mislead ourselves into thinking otherwise...
Higher interest rates will absolutely affect the prices of homes. The median income will remain generally unchanged. With a constant D/E ratio, homeowners will still only be able to afford certain monthly payments. If you are going to increase the int. rate this will lower the amt one can pay in principal. Thus, this will lower the price one can buy a house at. Buy a house when int. rates go sky high and refinance when they come back down.
In a Barron's Roundtable interview, Bill Gross that these interesting comments:
"...there is too little return on money. Central bankers don't understand that because their models don't permit it. There has never been a time, other than the Japanese experience of the past 10 years, when money that doesn't pay a return deflates instead of reflating. In the past 30 years the Federal Reserve lowered interest rates in the hope that credit markets and risk assets would expand proportionately. It worked. But when you get down to zero interest rates, things start to change. The world changes from Newton to Einstein with regard to the physics of money."
"When money yields nothing, banks won't lend it. If a bank can keep money on deposit with the Fed at 25 basis points [a quarter of a percentage point] or lend it at 27 basis points, the yield on a two-year Treasury, why take the two-year risk? The combination of low return and high risk basically freezes the system.
"What would you have done if you were running the Fed?
" I would have stopped cutting interest rates at 1% before we got to zero-percent money and the destruction of financial and business models. In a reserve banking system, there is the potential for abuse, and there has been abuse in moving beyond 10-to-1 leverage and into a shadow banking system, rehypothecation and such. The ability to expand credit, which prior to central banks was a function of local and state entities and the private market, has blossomed into a monster beyond control.
Bill, How would you reverse this credit creation?
"I would try to slow credit creation gradually but not reverse it, because it is the reversal that creates economic destruction. I would implement additional regulatory measures limiting the ability of banks, investment banks, hedge funds and, yes, Pimco, to use credit. Investors have run amok in inventing new ways to bet on the horse race. Credit-default swaps are extensions of gambling."
With all due respect to Mr. Gross, I have a very difficult time understanding exactly what it is he is saying. I think he mixes at least one too many metaphors.
For the chart Benjamin wants to see, go to the Federal Reserve Bank of St. Louis – FRED. Get the 10 year Treasury constant maturity rate chart DGS10. It goes from 1960. It shows rates are ridiculously low. Bonds have been in a bear market since the double dip in the early eighties. Why? Too much financial engineering?
If the economy can collapse from rates going up some from here we have bigger problems to worry about.
Sorry, Scott, my bad: a non selective, copy and paste on my part.
Perhaps a better example for Gross to have made would be: why would a bank want to make a 30 year mortgage at a 3.9% annual rate or a commercial loan of any significant duration at these historically low rates - unless they can immediately sell them to an entity which bundles them into a sort of bond.
As Gross said: "The combination of low return and high risk basically freezes the system."
Gross seems to ignore the fact that bank lending to small and medium-sized business is growing at double digit rates. Banks can lend to all sorts of borrowers for much more than 0.25%. Banks almost never hold on to mortgages they buy; the biggest mortgage brokers simply package the loans for a fee and sell them; many also do the servicing on the loans for a fee. Most of the interest rate risk of mortgages is born by institutional investors who buy MBS.
It's also quite obvious that banks are lending since all measures of money supply are growing at pretty decent rates.
I like bill Gross, but he seems a bit whacky of late.
However, he makes a key point---deflation is very much a risk today, as the Japan experience spells out clearly.
Some say the CPI is showing inflation, but the CPI overstates inflation. The Cleveland index suggests we are well under 2 percent on the inflation watch, and still some quarters are braying for tighter money.
It has long been inexplicable to Western central bankers who the Bank of Japan allowed a 20 year perma-rcession deflation to go on (and still going on).
You get of sense of how by listening to the US debate. There are the usual Chicken Inflation Littles with their pompous pettifogging everywhere. They have real clout in the GOP (although I suspect if Romney can win, the bluster about inflation will evaporate).
Some even advise the central bank's sole mission should be to control inflation to zero or even less. The Bank of Japan did that, and it was an epic failure. (Set aside how you measure measure inflation so precisely when goods and services are rapidly evolving, and businesses and consumers are constantly migrating to better deals).
When money becomes a store of value, your economy will implode. It makes sense to keep money in a suitcases---and since prices are going down, why not?
Why not hold off investing until next year, when prices are better? And why lend money when borrowers especially on real estate) will be hard up to pay it back?
Man oh man, people who call for no inflation and a strong dollar don't seem to know how this modern economy works.
See Japan.
"People will buy real estate if they think the bottom has been reached. Sheesh, people were buying real estate like hotcakes in the 1980s at double digit interest rates.
There could be an outright explosion on the upside n current real estate. "
Ben Jamin, despite good news and good charts, this recovery is extremely weak...
Thus in such an environment, a struggling housing market (no other description will do)rising rates will have a negative effect..
This is not the 80's, Ben, as people will purchase a home for shelter rather than an "investment..."
Rising rates outside the real estate market, will have little dilatory effects, as Mr Grannis has pointedly stated..
Interesting comment by guy above to go back 30 to 40 years and compare the ups and downs of mortgage rates, not just a few months or the odd year.
Loan modification is a permanent change to the terms of your mortgage or home loan.
loan modifications
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