What the Crystal Ball Says About Rates

Article By:  The KCM Crew on January 27, 2011
Courtesy of Keeping Current Matters


Predicting what will happen with interest rates is risky for a person’s credibility.  Last year at this time, I (and the KCM Crew) believed rates would climb after June and for very logical reasons: the end of the Fed’s purchase of mortgage-backed-securities (MBS) and the end of the Tax Credit. What we didn’t anticipate was the collapse of the Greek economy.  

That being said, I firmly believe that my opinion on the topic has some value. So, here’s my opinion (which assumes the governments of Ireland, Spain and Portugal stay solvent and no other major geo-political event occurs- like a war or terrorist activity).

The Fed and the federal government have publically (sic) stated their desire to get the American Economy back on track.  Their goals:

• Creating Jobs. They want to put Americans to work.
• Improving Production in the corporate and manufacturing sectors (which will create jobs and profits)
• Ratcheting Up Inflation in order to get prices moving upwards (really as a prevention of deflation)

Accomplishing these goals will likely improve the fortune of businesses (by creating higher sales, profits and stock prices).  In turn, the expectation is that these businesses will expand (spending money and creating jobs).  The money spent and jobs created will beget more spending in the private sector which will, in turn, create more sales, profits and jobs for the businesses.  Logical? Yes. Simple to accomplish? No.

Rewind 18 months: the Fed decided to buy massive quantities of mortgage-backed-securities to keep rates low (which encourages businesses to borrow and invest….and to refinance their existing debt to help their bottom lines).  Unfortunately, there was little confidence in the plan and many businesses instead of expanding, actually tightened their belts. You see, CONFIDENCE is a crucial component to any recovery.  There wasn’t enough confidence (look at the November elections as proof).

But in the last few months, Americans seem to have to begun to feel that things can and will improve.  QE2 has encouraged borrowing and expanding.  Jobs are starting to come back slowly. The infusion of $600 billion into the economy from the Fed via their new MBS purchase program is both inflationary and helpful in devaluing the dollar abroad (which allows foreign money to buy more American goods and services for less).  That helps improve sales, profits and jobs for businesses here.  The wheel is beginning to grind its way in the right direction.  At least, there is some confidence in that plan.
How is all this likely to affect mortgage interest rates?

• Inflation is always…bad for rates
• More jobs is inflationary…bad for rates
• A strong stock market…bad for rates
• A devalued dollar helps companies selling abroad and their stock value…bad for rates
• Consumer Confidence typically good for stock prices…bad for rates

Conventional wisdom is that, while rates have climbed from the low 4s to about 5% already, 2011 looks to be a volatile year with rates bouncing from 4.75% to 5.5% throughout the year. That’s a significant range and it behooves home buyers to pay attention and strongly consider locking in their rates when they are 5.125% or lower. 

Additionally, home sellers need to recognize that a .75% hike in rates makes a home about 8% more expensive to afford monthly. As we know, buyers don’t buy on price but instead buy on monthly carrying costs. Sellers are going to have to lower their prices by 8% to achieve the same cost for their buyer.

That’s my prediction in an unpredictable world….Let the debates begin.