Is the Party Over?

Regular readers of this column will recall that on a number of times I have called predicting interest rates a “most dangerous profession.”   In the last six weeks we have been through the most dramatic increase in long-term interest rates in almost twenty years.   If those who claimed any proficiency in prediction had any real ability, you’d think that someone would have predicted it. But I defy you to go back through the business publications and find anyone who predicted this one!

In the last article I wrote before going on vacation, What Happens When the Fed Lowers Rates – Part 3 I noted that the 10-year Treasury bond, which most closely mirrors the mortgage market, had jumped about one-half percent.   That increase has continued with the yield now standing at 4.35 percent, up from a low of 3.2 percent in mid-June.

Mortgage rates also bottomed out in mid-June with the 30-year fixed average at 5.21 percent according to FreddieMac’s weekly survey. That same rate is now 6.14 percent, almost a full percentage point higher. Short-term rates, by the way, are up only slightly.   The 1-year Treasury average yield is 1.13 percent, up from a low of .95 percent and at the same level as at the beginning of June.

What are the reasons?   Well, my feeling is that markets don’t need “reasons” in the sense we usually mean it. As I said three weeks ago, the economic scene seems to have a mix of good and bad economic data.   Productivity has increased, a good thing, but it also means that businesses are able to produce the same amount of goods with fewer workers, not a good thing.   You see what I mean.

The most interesting new comment that I have read suggests that investors in the market fear that the Federal Reserve System may have lost it’s ability to affect the economy.   Certainly with the Discount Rate at 1 percent, they can only lower it to zero!   If that is the case, we are going to continue to be more at the mercy of what goes on in the rest of the world.  

Indeed, having just gotten back from Europe , I can tell you how darned expensive it is to buy things with dollars in a Euro-based world.   One Euro costs $1.13 today compared with less than $.90 the last time I took a trip.   Looking at it another way, foreign investors who bought our Treasury bonds may have gotten a 4 percent yield, but when they turn it back into their own currency, they will get substantially less for it, like getting $.80 for every dollar originally invested!   Those are real losses and certainly affect the appetite of foreign investors to keep buying our Treasure bonds.   And of course with mounting deficits, the Treasury will have to issue more debt securities to finance it. You can see where that goes.

So is the party over? Well, it probably is for those who had 6 percent mortgages who were trying to refinance into 5 percent loans. The loans of perhaps a half-million recent applicants will never get funded unless we see another pull-back.   But for the rest of the economy, the party is not over.   Indeed, those who managed to get rates in the 5 percent range just have to count themselves among the lucky> Specifically, it doesn’t mean that the housing market is going to come to a screeching halt.   Even if mortgage rates stay in the 6 percent range, housing continues to be very affordable for many, many people. After all, most of the homes sold in the last twenty years were sold with loans that were 6 percent or higher.

On a longer-term basis, with rates where they are today, it would also seem to make sense for people to consider buying an investment property.   On an historical basis, the long-term returns for those who buy now will be quite attractive.