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  1. Home
  2. / Investing
  3. / Economic Data

Mortgage Rates Are Rising Faster Than Ever

But remember, rates have risen from very low levels and remain historically low.
By ROGER ARNOLD Aug 20, 2013 | 05:00 PM EDT

The rate of increase in mortgage rates since May has now exceeded the previous fastest rate of change in U.S. history. The immediate principal question for investors, mortgagors, builders. economists and policy makers to consider is what happens now.

The previous fastest rate of increase in U.S. history (the 13-week annualized rate of change of the 30-year fixed rate mortgage) occurred in 1980, and the next-fastest rate increase occurred in 1994.

Over the past few months, I've written a few columns about the impact of rising Treasury yields and mortgage rates on the economy in general and on the housing sector specifically, using the events of 1994, the last time mortgage rates spiked, as a reference point. 

The immediate fallout of a decrease in housing activity is starting to happen, as discussed in the previous columns, and this will be revealed empirically in the various housing and mortgage-related data series over the next several months.

This is also beginning to cause some concern to homeowners and buyers, builders and investors across all asset classes.

Let's put these events into a longer-term context. Although mortgage rates have risen recently at the fastest pace in history, they are doing so from the lowest levels in history, and rates are still low in comparison with those of the past several decades in both nominal and real terms.

Unless mortgage rates and Treasury yields continue rising at near the same pace of the past few months, the economic impact will be mooted as consumers and investors acclimate to the new rate environment. 

Right now, the concern of investors and mortgagors is where rates are today, compared with where they were at some point in the near past. Once consumers and investors have acclimated to the current rate environment, the next issue will be to try to anticipate how that relates to what rates will likely be in the future. The perception of debt being more expensive than it was two months ago will flip, and consumers and investors will consider debt to be cheap in relation to what is probable in the next several years.

Since the financial crisis of 2008, the publicly traded sovereign debt of the U.S. has doubled and is now at $12 billion, equal to about 75% of annual GDP of about $16 billion.

Sovereign-debt-to-GDP levels above 70% are considered dangerous, because this leaves very little room for the government to respond to a future economic shock with increased spending. It's like not having insurance; it's imprudent.

If the U.S. suffers another similar financial crisis, the requisite debt-funded fiscal stimulus to counteract the private-sector contraction would almost certainly push the U.S. government beyond the terminal insolvency point. 

Policy makers, both fiscal and monetary, must focus their attentions over the next decade to reducing the sovereign debt as a percentage of GDP in order to rebuild a buffer for the sovereign capital structure that will allow for another crisis response without bankrupting the government.

There isn't enough time, nor is there an expectation of private-sector growth that will be strong enough to allow the U.S. economy to grow its way out of the current sovereign debt.

At some point within the next few years, it is most probable therefore that the U.S. government and Federal Reserve will try to decrease the sovereign debt as a percentage of GDP by trying to inflate away some portion of it.

This will require having a large spread between short-term rates and long-term rates. That will be achieved by implementing monetary and fiscal policies that support higher long-end Treasury yields.

Since mortgage rates are tied to the yield on the 10-year U.S. Treasury, as the 10-year yield rises, mortgage rates rise. If we assume that the government is willing to shrink the debt by way of inflation over a period of no less than 10 years, mortgage rates 10 years from now and lasting for at least 10 years after that will have to be 10% or higher.  

The debt costs on a mortgage at 10%, rather than one at 5%, are 63%. That also means that for the same loan amount, a borrower would have to have 63% more income to qualify for a mortgage at 10% than at 5%.

That also means that even if home prices do not increase at all over the next 10 years, a borrower's income would need to increase by 5% annually just to maintain the purchasing power that he or she has today, while mortgage rates are at 5%. That's a highly improbable scenario.

The bottom line for home buyers is that although purchasing power is lower today than it was two to six months ago, it's still higher than it is likely to be for the next few decades at least. From this point forward, affordability will most probably steadily decrease.

Investors in homebuilders and in related companies should view a negative correction in the value of the stocks of companies in this space as a buying opportunity. The homebuilders' stocks have not yet priced in the probable reduction in sales, revenue and earnings that will become evident within the next few months.  

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TAGS: Economic Data | Investing

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