Why are interest rates moving higher, and will it continue?
Interest rates have moved very quickly since the election and several theories have emerged as to why.
Initially, many analysts thought it was a temporary move higher, a knee jerk reaction. But nearly a month after the election, the follow through on the move higher is taking shape with continued momentum higher. The question is: why are rates suddenly moving higher and is this the start of a new long term trend? Ray Dalio, billionaire founder of one of the worlds largest hedge funds sees a major reversal in the US including “increased US growth, higher inflation and rising bond yields (interest rates). We think that there’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation.” Hedge fund manager talk can be confusing, but keep in mind that the price of a bond has an opposite or inverse relationship to the yield/interest rate. So if he’s calling for a 30 year top in bond prices, that’s the same as calling for a 30 year low in interest rates. As you can see below, rates have been dropping for 30 years, at some point it would make sense they would go back up. As you can see, anything below 5% to 7% is pretty darn good.
Ray Dalio’s outlook to a certain extent was validated on Thursday when Federal Reserve Chair Janet Yellen testified before the Joint Economic Committee of Congress appearing to confirm recent economic data have been strong enough to persuade the Fed to raise interest rates during its December 13–14 FOMC meeting. Yellen said the Fed could raise interest rates “relatively soon if economic data keeps pointing to an improving labor market and rising inflation.” Yellen said the case for a rate hike had strengthened with the economy appearing on track to grow moderately, which would help bring about full employment and push inflation higher toward the Fed’s 2% target.
So where do rates go from here? It is hard to know; look at the head fake we saw in summer of 2013, rates moved from around 3.5% to nearly 5% in a month or two, then continued their longer trend lower back down to the 3.5% range. However, this time the trend did not break below the 2013 lows before moving higher as you see to the right of the screen below. This is a technical indicator that we might be looking at higher mortgage rates, at least in the short term.
But are higher rates always a bad thing?
A normalization of interest rates (below 5% is not normal) is a sign of a healthy economy, higher rates typically indicate economic growth, lower unemployment and potential for income / wage gains as the economy heats up. These are very good things that offset the cost of higher interest rates. For those of you who own homes, take solace in the continuing home equity appreciation numbers. It’s still a great time to buy with interest rates being near the 30 year low today. With home appreciation and interest rates moving higher, renters who have not locked in their home price or interest rates can surely count on higher housing costs in the years ahead.
With change comes questions; I’d be honored to answer those questions and advise you, your colleagues, family, and friends on their next home purchase.
This is a guest post by our friend Josh Mettle the director of Physician Lending at Fairways Independent Mortgage Corporation.