Interest rates do not seem to be getting a break. February has been one of just a few months over the past two decades leading to a 0.50% rise in the mortgage rate. Despite hopes to the contrary, March is also not a good start. Paradoxically, this rate drama means that everything goes according to plan.
Why is this?
Because the ‘plan’, in this case, is to win the war against the pandemic. This is, of course, a multifaceted issue and the war is far from over. But most of the fighting has detrimental consequences for rates if it goes well.
At the most basic level, as covid declines, the economy improves and a strong economy is the main inspiration for rising rates.
Inflation is a closely related concept to general economic growth because more “demand” in the economy results in higher prices, all other things being equal. Inflation is also an enemy of bonds / rates (ie higher inflation = higher rates).
There is currently a healthy debate about how much inflation is raising the recent interest rate. Some give almost all the credit fears of hyperinflation while others are not too worried. The following table puts things in context. The orange line shows how traders actually bet on inflation, from moment to moment, and the blue line is the actual returns of ten yrs. If inflation were the only driver, these lines would move at the same pace.
This is not to say that inflation is not a relevant fear of rates. It definitely contributes to higher rates in the slightly longer term (just not as much in the last month or so). Here is the same graph with a much wider view:
As far as the Federal Reserve is concerned, any major rise in inflation in the short term will be a temporary by-product of covid-related supply constraints and computational factors. Specifically, ‘year-on-year’ figures will soon be based on months in 2020 that had exceptionally low inflation (ie in April 2021 will probably always look quite high).
The Fed will continue to purchase treasury and mortgage-backed securities (MBS) until they are confident that their goals have been achieved, both in terms of inflation and the labor market. Fed Chairman Powell reiterated this commitment in a webcast during the WSJ Jobs Summit on Thursday, but the position is so well known that it my consolation to those on the rising rate.
For some reason, some traders have begun to speculate that Powell and the Fed would throw a bot to the bond market after a few weeks of rapidly rising rates (i.e. say or do something to lower rates a bit). It’s not necessarily far-fetched, but the buzz was centered on ‘Operation Twist“- a previous Fed policy that involved selling shorter-term bonds and buying equally long-term bonds. In this way, the Fed can continue to spend the same amount of money while putting more downward pressure on long-term rates that benefit consumers. .
Just a problem: the Fed has said very clearly that it is off the table. It was a possibility at the end of 2020, but they unanimously fired it. Several Fed speakers have repeated the decision in recent months. In addition, almost every Fed speaker over the past few weeks has made a combination of the following points as rates have risen:
- the rate hike reflects broad economic optimism and progress towards the pandemic
- rates at these levels are not currently concerned
In other words, rapidly rising rates are a logical by-product of what is going on with the economy, the number of cases and the progress of vaccination. They are “good news” even if it’s bad news for fans of low mortgage rates.
Powell stuck to the same text, and the markets settled a bit. The following graph shows the Powell response along with the two other notable rate hikes of the week, one driven by Europe, and the other one by a strong job report.
Bottom line: rates have risen for understandable reasons, even though the pace was surprising to some. Since the Fed approves the interest rate as proof of progress, you should not be surprised if the pace can continue – well … you will be surprised.
Om na mortgage rates, specifically, ended the week with fixed rates of 30 years, exactly in line with their highest levels in almost a year. Most mortgage rates will not mention this because it is based on Freddie Mac’s weekly survey which has yet to bring reality to the forefront (especially for refinancing rates, which are slightly higher than purchase rates).
The rate hike in 2021 has existed long enough for a visible toll on mortgage applications. Right levels are still very strong, and there are, of course, other factors at play, but the correlation is solid. It seems that the interest rate has greater implications for the buying market, but the previous precedent points to a greater supply of “other factors” behind the move (i.e. purchases are not nearly as bothered by rising rates, nor are they tends to respond so quickly).
So there is also any hope? Can rates soon return to levels of less than 3%? Will they continue to move much higher?
Be prepared for rates to be stubborn to move lower quickly. The economy has a lot to look forward to. It will take time before some of the more economically cumbersome scenarios play out in a way that helps rates significantly. If we see things improve in the short term, it will probably be due to behind – the – scenes trade motivations that have nothing to do with economic growth, inflation or Fed policy. In other words, they will be largely technical in nature, and thus not something to plan on.
What about stocks? Can stocks / shares help if stocks fall?
This may help to some extent, but I would like to warn anyone against expecting high rates to cause sustained sales in stocks which in turn helps to bring rates back down. It was a general refrain at the end of 2018, but it was certainly not that simple. In addition, the two time frames differ in different important ways. Will you be able to see stock prices and bond yields move like this? Yes …
But the move does not always mean that rising prices are hurting equities. More importantly, the takeaway can change as we zoom out.
So there is also any grain of hope?
Absolutely! There is always hope. Rates rise just as much, so fast before the market corrects. While it is impossible to know how the new reality of the pandemic will affect the normal time and extent of such things, it is no less certain. If you need a rate chart to put the super image into perspective, the returns of ten years over the past few decades are always a good choice.
