Say goodbye to low interest rates

Say Goodbye to low interest rates.

What a difference a month makes.  It was only one month ago that we were experiencing new lows in mortgage rates, even with the prospect of the Fed slowing raising interest rates at upcoming FOMC meetings.  The 10 yr Treasury Bond, the closest bellwether to mortgage rates, was sitting at 1.77% a month ago (10/17) and markets were calmly awaiting the December uptick in the Fed Funds rate.  This morning we are looking at a 20% increase in the interest rate on 10 yr Treasuries to 2.25% - most of this increase since the selection of Donald Trump as President-Elect.  While some of the increase in rates can be attributed to a shift in investment funds out of the bond market and into the stock market (which has seen a rally since the election, yet not a substantial one in the S&P 500 - only +1.5%), I believe we are seeing different economic risks driving the bond market and ultimately mortgage rates this week.

What to expect from a new administration

I'm not certain if I have ever seen, in my lifetime, more uncertainty about the ultimate policies of a Presidential victor than what we have in President-elect Trump.  In many ways, he was purposefully vague about the actual policy prescriptions he would offer and since the election has been backing away from some of his policy stances.  But given that he will likely be guided by the Republican-controlled Congress, here are a few things we might anticipate:

1) Tax cuts:  Trump endorsed the Republican plan for tax cuts, with his own twists on corporate tax cuts.  All of these plans have been proposed without offsetting cuts in expenditures, so expect growing deficits and debt in the federal government.  These will be exacerbated by higher interest rates - increasing debt service levels paid by the government.  The Republican expectation is that economic growth will soar with these tax cuts.  Yet the last two major tax cuts by Republican presidents (Reagan in 1981 and Bush in 2001), each produced growing debt and inadeqate real economic growth.  Debt financed fiscal stimulus such as this can be inflationary and given our starting point for interest rates, we can expect rates to point north.

2) Inflation returns: a number of economic policy proposals by Trump point to a disinterest in the rate of inflation: a generally protectionist economic stance, a disinterest using government regulations to control ever-expanding medical cost trends, an anti-foreigner stance (including foreign labor), and no policies on reducing deficits and debt.  The Federal Reserve has a target of 2% for the inflation rate (historically low), so any signs of inflation will likely be met by increased Fed Funds rates.  The good news is that the Fed Funds rate is so low, that there is plenty of room to grow.  The bad news is that we have gotten so used to low rates that a more rapid increase in rates will likely be quite an economic shock.

3) Housing policy changes on the margins:  We can expect much of the CFPB regulations to be overturned (as regulatory overreach) and potentially the elimination of the CFPB altogether (or defunded).  Much of Dodd-Frank will likely be changed, but here is where there may be some difference in views between the corporate interests in the Republican Party and the populist anti-Wall Street propositions of Trump.  There were no proposals during the campaign regarding the reorganization of the GSEs (Fannie Mae and Freddie Mac) and no apparent agreement around how to re-create a private secondary market for mortgages.  I anticipate no changes here (particularly while the GSEs continue to make money that feeds the government coffers).

Bottom Line:  Higher Interest Rates

We haven't seen 5% or 6% mortgage rates in awhile, but I believe we are on a road to see them once again.  For Americans that have taken advantage of the hot housing market through incredibly low-rate ARMs, we could be in for another stretch of foreclosures as rate adjustments extend payments beyond the reach of some of these homeowners.  Higher rates will also slow the rate of growth in housing prices, which has been on a hot streak lately.  Price increases were already slowing - this could put the breaks on price growth altogether.  Demand for housing will also slow as affordability will take a hit - I predict a greater hit from higher rates than from any possible decline in home prices.  Given that housing demand is so high right now that national housing inventory is at historic lows (particularly for a growing economy), we can expect a growing shift from a sellers market to one that is that is more in balance between buyers and sellers.  This is relatively good news, as long as we don't skid into recession.  

Much remains to be seen - RIP low mortgage rates.