Wednesday, December 30, 2009

Higher interest rates are not a big concern

In my predictions for 2010 I say that 10-year Treasury yields should rise significantly, ending up higher than 4.5% by the end of next year. Predicting sharply higher bond yields brings with it a prediction of higher mortgage rates, and that apparently makes a lot of folks very nervous about the housing market. I post this updated chart of mortgage rates to calm those fears. Even if 10-yr T-bond yields rose to 5%, that would probably result in 30-yr fixed mortgage rates of about 6.75% (conforming) and 7% or so (jumbo). In the great scheme of things, these are not very scary, and would amount to simply rolling back the clock to the late 1990s, when the housing boom was already underway.

It's also important to note that we won't be seeing 5% Treasury yields until and unless the economy is doing appreciably better, and/or inflation is picking up. More inflation and stronger growth would imply higher incomes, and that, despite higher interest rates, would combine to keep housing more affordable for most folks than it has been for a long time. Higher rates would also give an impetus to buyers sitting on the fence: "buy now before rates go higher."

Other folks worry that banks aren't lending. It certainly looks more difficult to get a loan today than it was just a few years ago. But at the same time, the Fed has already provided the banks with all they could possibly need to ramp up lending. In time they undoubtedly will, since the spread between banks' cost of funds and what they can charge consumers is huge, and the yield curve is very steep. Moreover, I'm not willing to underestimate the ability of this country's finance whizzes to figure out new ways of lending. We're in a period of great creative destruction, and innovation is more likely than stagnation at times like these.

Is Fed tightening a threat to growth? No. Interest rates are ridiculously low right now. So low, in fact, that they make a lot of people nervous about the future: How will the Fed exit its quantitative easing strategy; how high might inflation go; what if China stops buying our debt? These concerns weigh heavily on the dollar, which is very close to its all-time lows. That in turn makes global investors think twice about putting their money to work in the U.S. The uncertainty surrounding monetary policy and the problems this poses for investment is a major headwind for the economy right now. Markets would be much happier, and growth fundamentals much stronger, if the Fed were to surprise people by snugging up monetary policy tomorrow. Doing the right thing is always better than continuing to make a mistake.

So I'm not worried about higher interest rates. In fact, I welcome them and hope they come sooner rather than later. No economy that I'm aware of has ever been able to fool its way to stronger growth and higher living standards by debasing its currency.


alstry said...


Your blog is truly a breath of fresh air during these times of conflicting data.

I was reading somewhere that our deficit is so high if we taxed the top 10% of income earners, those earning over $100K per year (paying 70% of total income taxes) 100% of their income, it wouldn't be enough to bridge the current deficit at current interest rates.

If interest rise, wouldn't that put even greater strain in the deficit?

Donny Baseball said...

Let me second that Scott. CBP has been a fantastic read all year, you have done a remarkable job. Plus you made a great call.

I agree with this post, people don't seem to understand that rates rising from, say, 1% to 3% is not the same animal as them rising from 5% to 7% although the magnitude is the same.

Aside from the sheer size of our government's debt are you worried about the term structure, we seem to be issuing alot of relatively short term debt. What happens in 2-3 years when we go to roll it over. Like you I have been long TBT and made a buck or two, but is TBT just getting started??