Interest Rate Hysteria

As I write today, the 30 Year Fixed Rate on Mortgages is about 4.2%. Though MORT30 averaged higher than that in 2010 and 2011, it was below that rate recently and there is much concern that it, like other rates is soon headed upward. When I say there is concern I could also say there is near hysteria.  As I often like to do I checked some historical data and find little reason for undo concern.

Don’t get me wrong. If mortgage rates climb some people will be hurt. Change in any economic indicator has a tendency to penalize some while helping others. Prices of weed in Seattle have gone up since legalization and many puffers would probably prefer to go back to the good old days when the government was not taking its “fair” share of the profits. Inasmuch, prices and interest rates always cut in at least two ways. As you know, however, I am a card-carrying macroeconomist and as such am less worried about distribution and more interested in how indicators impact the whole economy.

Luckily we have macro indicators like real GDP that represent the macro performance of an economy. My data analysis looks at how changes in MORT30 have impacted real GDP.  And while this might sound heretical, I am seeing little concern raised by more than 40 years of annual data (1971 to 2013). That is, while it sounds obvious that increases in MORT30 ought to be terribly bad for the growth of the national economy, there is really very little relevant evidence to back that up.  Today some of us are very worried that the Fed will change policy, jerk interest rates upward, and return us to a terrible recession. The data do not support such a worry.

First I look at recession years. Did rising interest rates cause these recessions?  There have been 6 recessions encompassing parts of nine years since 1970. In three of those recessions -- 1973-74, 1980 and 1982, MORT30 increased and confirmed our worries. But it is important to point out that those years from 1973 to 1981 showed dramatic increases in inflation and MORT30 had reached over 16% by 1981. MORT30 increased from 7.5% in 1971 to 13.7% by 1980 and then 16.54% by 1981 (these rates are annual averages meaning that rates were even higher in some parts of those years). It is questionable how relevant those recessions are to today’s situation of low inflation expectations and interest rates.

In none of the three remaining recessions (1990, 2000, and 2007/2008) was there any interest rate increase during the recession. In most cases MORT30 was falling during or immediately before those recessions. It is seems unclear from this recession analysis that higher interest rates will cause another recession in today’s environment.

Second, I examine the time periods when real GDP growth declined. Did rising interest rates cause slower annual growth? There were 22 years between 1970 and 2013 when the growth rate of the economy declined. That is, the growth of real GDP in those 22 years was less than in the previous year. In nine of those 22 years interest rates rose in that year. Of those nine times when the interest rate rose during a slow growth period, in only five of those cases did MORT30 rise by more than 100 basis points in the year before and the year of the slowdown. In one case MORT30 fell by 222 basis points in those two years before and during the slowdown. There must have been something else contributing to the economic slowdowns in those 22 years. 

In the other 13 slower growth years MORT30 was falling.  If we combine the year of the slowdown with the year before, we find only one year in which there was a substantial rate rise of more than 50 basis points over those two years.

The great majority of recessions and one-year slowdowns are not associated with rising interest rates. Increases in interest rates did have large impacts on real GDP back when rates were historically high and rising but not so much when rates were more normal.

Finally, we turn to the times after 1980 when MORT30 rose more than a few points. What happened to real GDP in those years? 

1993-1994 MORT30 rose from 7.3% to 8.4%. In 1994 the rise of 110 basis points was associated with real GDP growth rising from 2.7% in 1993 to 4% in 1994. Growth did slow in 1995 to 2.7% as interest rates were declining in that year.

1998- 2000 MORT30 rose from 6.9% in 1998 to 8.1% in 2000. That was an increase of 111 basis points in two years. In each of those three years real GDP was increasing at rates above 4% (4.4, 4.7, 4.1). Real GDP grew at only 1% in 2001 but rates were declining in that year.

2005-2006   MORT30 rose from 5.9% to 6.4% for an increase of about 54 basis points that year. In those two years real GDP growth was 3.3% and then 2.7%. By 2007 economic growth fell to 1.8%  and by 2007 we were in a full blown recession.  That recession was attributed to a financial crisis emanating from a bubble in the real estate markets.

Rising mortgage rates do not bode ill for the economy. Often the rising rates are more a symptom of an expanding economy and less a precursor of a coming economic slowdown. Clearly the record is sketchy at best. Most clear is the danger of rising rates in a hyper-inflationary environment.  Lacking such a situation, the Fed can go ahead and let rates start to rise and not worry about economic fragility. The economy is growing and can take the hit. A bigger risk is that by waiting too long to let rates return to normality the Fed threatens a much bigger spike in rates and a return to some of the gloomier days of the 1970s.

I loved my 8-track player, disco music, and my Travolta-like dance moves but I am in no hurry to return to the 1970s.

Rising Mortgage Rates will not Kill the Housing Recovery

Cartoon by Jim Gibson



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.