Are You Sure that Rates are Going Higher?

A View from the Beach

A View from the Beach

The big question in real estate finance, in fact all finance markets, is the direction of future interest rates.  The experts are all predicting higher interest rates, both short and long term, and in my world, that means higher long term mortgage rates and quickly increasing home equity line of credit costs (whose rates are typically tied to the short term Prime Rate).

But, what if we don’t see higher mortgage rates.  What if mortgage rates actually drop and stayed low again – say for the next 12 to 24 months.  Could an argument be made that this scenario may play out?

A recent blog post from the Stratmor Group outlines a good rationale supporting this proposition.  The full post can be read here:  Are You Sure that Rates are Going Higher?

The “smartest guys in the room” might be wrong with their forecasts, and that the era of low rates might stick around a bit longer. First, the Trump agenda might pack less of a growth punch than some have imagined. If so, you would expect the same cautious approach to rate increases from the Fed. The day after the election stocks rallied and bonds sold off/rates went up. Trump’s major tax cuts would tend to create a short-term boost in economic growth and higher interest rates. But there are some early signals that the Republican lawmakers who actually have to pass any changes to tax law, especially those in the Senate, are wary of tax cuts that would increase the budget deficit as much as Mr. Trump’s campaign plan would.

Interestingly, in the past several weeks we have seen a rally in the market for mortgage back securities which looks to be ready to break through a strong resistance line that was established when rates rocketed upward after the election in November.  Rates fell further in reaction to the Fed’s move in December, but have since rallied nicely.  The chart below shows FNMA mortgage backed securities pricing over the past three (3) months.  Remember that rates move opposite prices in the bond markets – i.e. as prices fall, rates increase.

mbs

Will the bond market break through the resistance line established back in mid-December?  If it does, we could see a strong rate rally, meaning a reduction in mortgage rates.  But that is the short term.

In the long term, there is still uncertainty.  As outlined earlier, the Trump agenda might not be as stimulative as some have thought.  And, there is always the risk that some of the President-elect’s policies could end up being a drag on growth – a trade war with China or Mexico for example.

Second, even if the economy does start growing faster, future Trump administration appointees could change their tune on the desirability of higher interest rates. Politicians, once in office, tend to learn that they like low interest rates, and there is starting to be chatter that some in the Trump administration will push for cheaper money and the Fed attempting to hold the line to prevent inflation.

Looking ahead, I would have to agree with the conclusion of the Stratmor Group.

Looking ahead, even if the Fed kept its short-term interest rate targets low despite rising inflation, long-term interest rates, which are determined by the supply and demand of the bond market, would probably rise. Mr. Trump doesn’t feel bound by the traditions that have governed how recent presidents have acted. So, the future of United States interest rate policy is uncertain – like everything else in the future – but no one should be sure that long term rates are destined to move dramatically higher if at all.

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