I do not know how many credit market columns I read last week that announced, lamented, and frantically worried about rising mortgage interest rates. It is as if a young couple fretted about the fact that their baby was reaching 22 pounds. For you people not from the US a pound is a unit if weight similar to a stone or a rock. Most babies start at about 6 pounds and keep gaining weight until they become tackles for an NFL team. It is perfectly natural for the child to reach 22 pounds at some point.
According to
the press, interest rates should not be allowed to grow up. I will admit that US interest rates got very
low. In fact a graph of the 30 year Conventional Mortgage Rate (let’s call this
interest rate Mort) shows that Mort has not been lower since 1965. http://research.stlouisfed.org/fred2/graph/?id=MORTG Despite recent increases in Mort, he is still below every single data
point since 1965 except the very recent time period starting from August 2010.
So rates are
rising but they are rising only in comparison to about two years of historically
low rates. Imagine living through a time period when the temperatures in Miami
in July were 180 degrees F. You would have to admit that 185F in Miami in July
is not normal. But then imagine when the temps went to 170F everyone started to worry about a coming freeze. People started cancelling vacations in Florida
because they thought it would be too cold. Crazy right?
The graph of
Mort is very clear. Starting in 1980 when interest rates rose to very high
levels, the trend has been downward. That is right, for almost 35 years,
Mort has been getting lower and lower. Of course there have been cycles around
the trend and that means there have been times when Mort rose. But every upward
phase was always followed by a downward one – one that left rates even lower
than when the phase started. Consider these average Mort rates ---
1985 to 89 10.7%
1990 to 94 9.2%
1995 to 99 7.6%
2000 to 04 6.7%
2005 to 09 5.9%
2010 + 4.2%
As I write
today Mort is about 4.5%. So it is higher than the 3.4% at the end of 2012 and
the 4.2% average since 2010, but it is now considerably lower than any of the
averages of the 5 year periods since 1965. It is also much lower than the
average of recent years before the world recession.
Why are we
so worried about Mort? The answer is that we are really worried about his
cousin Heloise (Housing Starts). Heloise has not been well. Heloise is a shadow
of her former self but has been improving of late. After coming in at a low ebb
of 478,000 units in spring of 2009, Heloise has been rising hitting about a
million starts in March of this year but settling in at a pace of over 850,000
starts since.
There is a
worry that if Mort rises more that this will diminish Heloise. But this does
not make any sense because it leaves out all those other variables that might
impact the demand and supply for housing. Even at one million units per month,
Heloise is more than a million starts below the previous annual peak and is
probably only 60% of what might be considered a past normal result. Heloise
remains weak despite super-record-low Mort. That means that there must be
something else besides Mort that is bothering Heloise.
That
something else is the same list of things that is keeping the general national recovery
at a slow pace and restraining employment. Among the items in that list is an
unfinished reform agenda that leaves banks and households uncertain about the
future of housing, banking, energy, healthcare and more. Interest rates can and will increase. But that should not be an alarming factor. It
should be just the opposite. The rise in interest rates is signaling a stronger
economy. The risk of another major
financial recession is slowly receding into the past. Output and incomes are
rising. Employment is increasing, albeit slowly. This foundation means that the
housing market will not vanish just because mortgage rates hit or exceed 5%.
While we
might not feel lucky the gradual US and world economic recovery will be a
good thing for Mort and Heloise. As Europe, Japan, China, and emerging nations
expand at a gradual rate, this puts less pressure on commodities and other markets
and should keep inflation in check for a while. This will keep Mort in check as
well. Note from the history cited above that trend Mort has come down for
almost 35 years. Much of that can be explained by a secular decline in inflation
and inflation expectations. So a key to Mort and Heloise happiness is keeping
those inflation expectations damped.
In short the
sky is not falling. Interest rates are going to keep rising as the economy gradually
recovers. Housing will not be unduly troubled as housing demand marches back to
more normal monthly starts. But a gradual recovery is not enough to guarantee
success. Much would be improved by a return to sane monetary and fiscal policy.
Removing stimulus means anchored inflation expectations. A sustained recovery is
impossible without it.
