FAQ RISING’ S RATES
RISING RATES AND RECESSION – WHAT DOES IT MEAN TO YOU?
BY: BARRY HABIB
THANKS TO THE FEDERAL RESERVE’ S reduction in its reinvestment of Mortgage Bonds and Treasuries, as well as an uptick in inflation, we have seen a noticeable move higher in interest rates. This has caused refinance volumes to drop to their lowest levels in over a decade. Add to that low inventory levels of homes for sale and we see application volume down for most companies. The excess capacity and fierce competition have led to margin compression. When does it end and where does it go?
will continue to hike rates, which will put upward pressure on the shorter term two-year Note. This means there is a very good chance that the yield curve gets inverted— meaning the two-year yield rises above the ten-year yield— within the next year. That’ s important because, as the chart below illustrates, an inverted yield curve is an early warning sign of a recession ahead. Notice how every time the yield curve inverts( red areas), recessions follow.
It’ s true that rates have risen. But make no mistake, rates are still really, really good. Look at the chart below to gain some perspective on just how terrific mortgage rates are on a historical basis. Your clients may benefit from this:
As mentioned, the reduction in Fed buying has pressured rates to the upside. There will be one more reduction coming in October, which should continue to move rates a bit higher still. Additionally, inflation, while mild, appears to be persistently creeping higher. Inflation is the archenemy of Bonds because it erodes the buying power you get from the fixed payment return. These factors will be a headwind for mortgage originators. The best way to overcome this is to articulate the opportunity in the still very healthy Real Estate market. The benefits received from appreciation and amortization dwarf the additional cost from higher rates. An advisor can help clients focus on what’ s important.
We have been forecasting a recession around the year 2020. We have two reasons for this. First, the flattening of the yield curve between the two-year Treasury Note and 10-year Treasury Note. Notice in the chart below how the difference between the two has been shrinking. About four years ago, the 10-year Treasury was yielding approximately 2.75 percent more than the two-year Treasury. But the spread between the two has persistently shrunk to its current levels near 0.25 percent. The Fed has told us that it
Another reliable recession indicator is the bottoming out of the unemployment rate. One of the first things that companies do when the business climate slows is to cut costs by letting people go. A look at the chart below shows a 100 percent correlation since WWII, where the bottoming out of the unemployment rate is an advance indicator of a recession. We are not saying that we are there just yet, but we are a lot closer to the bottom of the unemployment rate than we have been in a long time.
While a recession is never something we’ d want, because it will adversely affect some families, it as a period that coincides with lower interest rates. This is because the Fed’ s main tool to stimulate the economy is to lower rates or institute Quantitative Easing. This will result in lower mortgage rates and a highly probable opportunity for refinancing during this period.
30