Is the Recent Climb in Interest Rates a Real Threat?

Brian Burton

If you pay close attention to mortgage rates like we do, you may have noticed a fairly significant move higher over the last few months.  In fact, 30-year mortgage rates have risen in nine of the past eleven weeks, up 41 basis points from a low of 2.93 percent earlier this year, to the current rate of 3.34 percent.  This move higher is a result of the recent reversal in the rate on 10-year bonds issued by the U.S. government, as the yield on the benchmark bond directly affects mortgage rates.  The 10-year yield hit a low in August of last year when it fell to 0.51%, it closed the year at 0.93%, and currently sits at 1.70%.

Most believe the primary driver behind Treasury yields moving higher is the expectation of a strong economic rebound fueled by additional government stimulus and a nationwide COVID vaccination program.  The recent $1.9 Trillion relief package along with declining infection rates spurring states to reopen has resulted in what appears to be growing confidence and consumption.  Following the Federal Reserve’s two-day policy meeting last week, the U.S Central Bank said it sees stronger economic growth than previously estimated, forecasting GDP would rise to 6.5% in 2021, compared to a December prediction of 4.2%.

Addressing the Fears Associated with Higher Yields

Untamed Inflation – there is a bit of fear in the markets that we could see mounting inflation over the coming weeks resulting in possible interest rate hikes in the future.  While this is certainly an area to keep an eye on, the idea that inflation is going to run wild over the coming years seems like a bit of fear-mongering.  Remember, Fed officials have been desperately trying to get inflation up to their target of 2% for the better part of a decade, only to be labeled as failures as the rate of price increases sat consistently below their mark.  Even a massive fiscal expansion in 2017 as the economy was humming along, couldn’t breathe a breath of life into inflation.  Fed Chair Powell addressed the issue at a Jan. 27 press conference when he said, “It helps to look back at the inflation dynamics the United States has had now for some decades and notice that there has been significant disinflationary pressure for some time, for a couple of decades.  Inflation has averaged less than 2% for a quarter of a century.  Dynamics evolve constantly over time, but they don’t change rapidly.  So, we think it’s very unlikely that anything we see now would result in troubling inflation.”

Rate Hikes Chocking off Economic Growth – with ramped up expectations for economic growth and hints of increasing inflation, many are fearful that rate hikes are moving closer to a reality, spelling doom for long-term growth.  Just last week, the policymaking FOMC voted to keep short-term borrowing rates near zero, while continuing its asset purchase program of $120 billion of bonds per month.  Although a few of the committee members grew more hawkish on their view of future rate hikes, it was not enough to change the forecast of no rate hikes through 2023.  When addressing these inflationary concerns, Powell said he expects inflation will rise this year mostly due to soft year-over-year comparisons from early 2020 but that it would not be enough to change a policy that seeks inflation above 2%.  He added, “I would note that a transitory rise in inflation above 2% as seems likely to occur this year would not meet this standard”.

Rising Rates are a Negative for Stocks – as rates have moved higher on the 10-year, we have seen a strong correlation between these yields and the Nasdaq Composite, particularly with technology companies carrying bloated valuations.  How long this rotation away from tech companies that thrived in the stay-at-home economy into companies positioned to benefit from a reopening economy will last is anyone’s guess; however, history tells us that without a sustained inflation surge, rising bond yields should only have a minor impact on stocks.  Arguably the best hedge fund manager of all time, David Tepper, said it’s very difficult to be bearish on stocks right now and thinks the sell-off in Treasurys that has driven rates higher is likely over.  He added, “Basically I think rates have temporarily made the most of the move and should be more stable in the next few months, which makes it safer to be in stocks for now”¹.

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