Mortgage Rates Rise as Covid Cases Drop; U.S. Economy Moves Toward Reopening 

Rates are edging higher as the reflation trade continues to play out. Washington is pushing hard for another stimulus package to the tune of $1.9 trillion, putting pressure on the bond market even as equities stall. Covid cases are dropping fast around the country. We hope this will lead to the beginning of a return to normalcy as vaccinations and herd immunity take hold. If the recovery continues apace, the combination of pent-up demand and consumer confidence could yield very strong economic activity. This is partly why longer-dated interest rates are rising as the markets become more optimistic about a global recovery. 

Speaking of inflation, lumber prices have been on a tear which is causing some home builders to pause or slow down building activities. When the cost of lumber and other related commodities rises, it digs into builders’ profits. It also makes new homes more expensive. This in turn puts the brake on housing, which has been a huge part of our economy in the last year. If long-dated interest rates run higher, we fully expect the Fed to step in and control the yield curve with bond purchases.  

Keep a close eye on the upward slowing yield curve. The 10-year Treasury has quietly moved up to over 1.300%, dampening mortgage refinances. As mentioned previously, the odds of rates going higher seem greater than going lower, so now is the time to apply for a loan and take advantage of this extremely accommodative mortgage rate environment while it lasts.

As the prospects of a post-lock down world take shape, rates are quietly moving higher, while remaining still historically extremely attractive. The CPI inflation numbers were lower than expected. Food prices such as soy and corn, and other commodities such as oil and lumber costs are moving up. If this trend continues, this may hurt consumption and drag down economic growth while also increasing the prospects of higher interest rates.  

Now is the time to take advantage of the exceptionally low-interest rates that were put into place to offset the downside risks of the pandemic. With Covid cases dropping, we are cheering for a return to normalcy, which will also mean a return to higher rates.  

Low interest rates have played a big part in boosting housing and auto sales, as well as boosting growth stocks and more speculative alternative assets such as Bitcoin. If rates move up too quickly, expect the Fed to intervene. The Fed has been clear that they will cheer on inflation while keeping rates low to help “juice” the economic recovery. However, we believe that the Fed will let rates rise to around 1.50% to 1.75% on the 10-year Treasury before considering yield control policy intervention. 

A downward drift in the stock market could also move rates lower. With many stock indexes globally at or above all-time highs, rates could push lower should there be a pullback.

Concerns of a heating job market abated with January’s lackluster jobs report. Bond yields began to move up mid-week on a better than expected ADP report and weekly unemployment claims in anticipation of an improving jobs market. The 10-year U.S. Treasury did close above 1.15% for the week, but some of the rate momentum was lost due to slowing jobs numbers. The jobs market has certainly improved from last year, yet there still remains many headwinds. Job improvement is being seen in education, professional, and business services while hospitality, healthcare, and leisure remain underperforming sectors of the economy. The unemployment rate checked in at 6.30%, down from last month’s rate of 6.70%.  

So what will drive rates in the coming months? We see (as do many) three main themes driving interest rates: (1) vaccinations and herd immunity (2) government spending and inflation and (3) business disruption and underemployment. Ultimately, the virus is in charge and will play the biggest role in the global economy’s re-opening and return to normalcy. More normal times portend higher interest rates. Massive quantitative easing, central bank stimulus, and government aid remain top of mind as well. Massive stimulus and government aid will eventually move interest rates higher as it becomes harder to see how all of this borrowing will be paid back. However, for the moment, the Fed is encouraging inflation. So far, it has created inflation in both the equity and real estate markets in the form of higher prices as a result of near-zero interest rates. The Fed is now hoping for wage inflation. While inflation has been feared over the last twenty years, this time may actually be different as the Fed vows to keep rates low even in an inflationary environment. Technological disruption and how business will be conducted post-pandemic also is playing a role. Tech disruption makes businesses more efficient but also costs jobs and in many ways creates deflation. Lack of full employment will force the Fed to keep interest rates low for longer, even after the pandemic passes.  

Housing and housing-related activities have played a big role in keeping the economy moving forward during these most uncertain times. The pandemic has certainly created a once-in-a-lifetime opportunity to lock-in exceptionally low-interest rates. We continue to remain very busy and grateful for our clients. Over the last several months, there was really no need to watch the bond market. However, that is now changing as rates begin to tick up and the yield curve steepens. For the moment, the small uptick in interest rates should not alarm any active borrower, but it may become a bigger factor in the months ahead. 

The first reading of 4^th quarter GDP showed a healthy gain of 4%, a promising number given how many states remain only partially open for business. However, not all is rosy, as weekly unemployment claims remain elevated, and fears of new, more contagious strains of Covid-19 weigh on how long this pandemic will keep us from returning to our normal lives. Vaccinations must be pushed through in a race against time. The more people are vaccinated before a mutation that becomes unaffected by current vaccinations, the sooner we will all be able to return to full employment, travel, go to stores, and eat out. As consumption is 2/3% of the U.S. economy, these activities are essential to rebuilding our workforce and our restarting our economy.

Inflation is making more news lately as it is showing signs of starting to rise. A look back on the cost of oranges, soybeans, and even oil, from a year ago certainly supports the inflation narrative. Homebuilders. while bullish on demand for housing, are concerned about the rise of lumber prices. The Fed is actually encouraging inflation while also stating that if needed they will institute a policy of yield control, by which the Fed would not let rates go above a certain level. We remain wary of such policies, but we understand the Fed prefers inflation to stagflation or deflation. Inflating dollars in the future to pay off debts today is one of the ways out of this massive amount of debt central banks have taken on due to the pandemic.  It also encourages people to own equities and real estate, two asset classes that are a hedge against inflation.  

In what has been a very strange week in the equities markets, i.e., Gamestop, AMC, and Blackberry trading huge volumes as the retail investors squeeze out professional investors who were shorting these stocks. This trading is quite dangerous and may suggest trading in stocks is becoming more game-like, more closely resembling gambling rather than investing. What received less attention was that rates have drifted slightly higher during this week’s spike in volatility, an unusual response as interest rates typically fall when equity markets become volatile. A one-percent 10-year Treasury note rate appears to be the resistance point. With inflation being encouraged by the Fed, we are becoming more aggressive in our recommendation to take advantage of interest rates at this time.

With the swearing-in of President Joseph R. Biden, a new administration takes the reigns from a most unusual four years. Treasury Secretary Janet Yellen didn’t hold back with her comments to “go big” on stimulus and assistance payments as the country continues to grapple with the coronavirus. Mass vaccination rollouts seem to be picking up steam which is a welcome sign as we all yearn to go back to a normal life. However, there will be some resistance from Congress to pump in another $1.9 trillion in stimulus as $900 billion was just committed not too long ago and has yet to make its way through the economy.  

Fourth-quarter bank earnings were strong overall and reserves for bad loans revised downward. These are all good signs. The yield curve has steepened as well, which will help banks earn more money on loan production. Housing sales remain on fire as people flee big cities for the suburbs or realize the need for a bigger home. Tech earnings from bellwethers IBM and Intel disappointed on Friday, which hurt equities. Interest rates remain over 1% on the 10-year Treasury. As we have stated previously, a 10-year Treasury at 1% is very attractive, and with the Fed encouraging inflation, borrowers are in a position where long-term mortgage financing can run negative versus inflation. For example, if a new mortgage is originated at a 2.75% note rate, but inflation is 3%, the borrower’s real interest rate is -.25%. As wages rise, the borrower will continue to pay the mortgage with inflated dollars, which increases affordability and also consumer spending as more dollars are available to buy other goods and services. Inflation should also help increase the value of the real estate asset, which adds additional consumer confidence.

With this thought in mind, no one knows for sure if inflation will run hot. It has not for over two decades. Many economists are worried about inflation, especially after the unprecedented amount of debt taken out by central banks in response to the pandemic. Our belief is that it’s likelier for rates to move higher than lower, so we continue to encourage borrowers to take advantage of these low interest rates and use this ultra-accommodative environment to refinance into long terms mortgages, or to lock-up a new purchase.