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Interest Rates Inching Up   May 7th, 2009
If you want to refinance, better get it done       


More observations...

Interest rates dropped late last year and have generally stayed low due to the Federal Reserve intentionally distorting the market. First they announced they'd buy up mortgage back securities and then they started buying U.S. Treasury Bonds. As I noted two months ago, this did have the effect of temporarily lowering interest rates (though the real purpose was to fund President Obama's deficit spending). But I also noted that in the longer term it would cause interest rates to rise. The only question was "when?"

While one can never be certain, it's possible we may have reached that point. We may have reached the bottom for interest rates and we may see them starting to go up.

Treasury 30-year bonds fell the most since February as investors demanded higher-than-forecast yields at today's auction of $14 billion of the securities with the U.S. slated to sell a record amount of debt this year.

'This is a problem,' said Chris Ahrens, head interest- rate strategist at UBS AG in Stamford, Connecticut, one of 16 primary dealers required to bid in Treasury auctions. 'The market required a fairly significant discount to buy the bonds.'

Thirty-year bonds have lost investors 20.9 percent this year, Merrill Lynch & Co. indexes show, as the Treasury increases securities sales to help fund a swelling budget deficit. Yields climbed to a six-month high today as the auction drew a yield of 4.288 percent, higher than the 4.192 percent average forecast in a Bloomberg News survey of seven primary dealers. Demand was below average, judging by total bids...

The auction's so-called bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.14, compared with an average of 2.24 at the past 10 sales of the maturity. Thirty-year bonds yielded 3.64 percent at the last sale, on March 12.

This is significant. Investors loaning money to the government to fund deficit spending are starting to demand higher interest rates for two reasons: 1) They think they can get better returns elsewhere (in the stock market) and, 2) Because there is an increasing risk of inflation due to all the money being printed by the Federal Reserve. Investors don't want to invest their money in something that pays 2% interest if inflation is 3%.

Indeed the same article notes:

Yields on longer-maturity debt also rose amid concern the government's spending, coupled with policies of so-called quantitative easing in which a central bank pumps money into the economy, will stoke inflation....

'There are global concerns about quantitative easing and its impact on the U.S. There is still uncertainty among investors as to whether the inflation risk wins out.'

The problem is that U.S. government debt is considered essentially "zero risk." So if investors are demanding 4.288% for 30-year no-risk government bonds, how much are they going to ask to loan money to people that want to buy a house? Considering offering mortgages has been a pretty risky business lately, you can be sure they're going to want a premium.

Indeed, the situation is having the expected impact on mortgage rates:

The average 30-year fixed mortgage rate jumped to 5.27%, up from 5.23% the previous week, according to Bankrate.com's weekly national survey.

And the above information from BankRate was released yesterday, before the bond auction drove interest rates north of 4.28%. Presumably mortgage rates will rise higher in lockstep with the increase in rates on U.S. Treasury bonds.

No-one can predict the future precisely. But with the 30-year U.S. Treasury bond rate rising to 4.288% (and beyond... in after-hours trading it's up to 4.31%) it would seem possible that interest rates have bottomed out and are starting their inevitable march back up.

Indeed when Obama took office the 30-year Treasury bond was at 2.95%. In the almost four months since then the rate has risen to today's 4.288%. That's a rise of 1.3% in four months. Mortgage rates, however, have fallen by about 0.25%. That difference is not sustainable. And since the rates for both 30-year and 10-year government bonds continue to rise, it's inevitable that mortgage rates will do the same (the only caveat is if the Federal Reserve continues to manipulate the market to keep mortgage rates low... in which case they're re-inflating the housing bubble and we'll pay for it with another collapse in the future).

If you've been meaning to refinance your home and haven't done so yet, I really think now is the time to get it done. I can't imagine rates going much lower and, based on pretty simple economics, it seems likely that they're going to start heading up.

    Update 5/28/2009: Three weeks after writing the above, the following article was published which essentially said the same thing--that mortgage rates couldn't continue to remain stable or fall while Treasury rates continued to increase.

    The yield on the 10 year bond has been climbing since early January, gradually putting pressure on mortgage rates. Until recently mortgage rates did not jump dramatically since the spread between the 30 year fixed rate mortgage and the 10 year treasury remained narrow.

    Some analysts have speculated that the Fed was able to manipulate mortgage rates lower over the short term through purchases of mortgage backed securities. Wednesday, the Fed discovered the limits of establishing artificial price points. The Fed may be able to manipulate rates in the short term, but the markets will ultimately set the price of money based on the reality of US financial conditions.

    It also means that longer-term loans to businesses to finance a recovery are going to be more costly. This is why conservatives correctly point out that increased deficit spending doesn't stimulate the economy--in fact, it starves the market of the money necessary to finance a true recovery driven by the private sector.

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