Why Increasing US Treasury Yields Is Trouble For Housing And Economy

While increasing rates on U.S. Treasury securities reflect the improving economy, a continued rise could mean trouble for the economy and housing market. One reason is that if …

While increasing rates on U.S. Treasury securities reflect the improving economy, a continued rise could mean trouble for the economy and housing market. One reason is that if money is more expensive to borrow, it may lower demand from home buyers. For more on this see the following article by Jason Simpkins from Money Morning

Yields on U.S. Treasury securities have soared over the past six months as the U.S. economy showed signs of a rebound and as investors braced for the possible return of inflation. However, while the higher yields signaled improving fortunes for the American marketplace, those higher rates could also undermine this turnabout by causing the improving stock-and-housing markets to stumble.

From its low of 2.04% in mid-December, the yield on the 10-year Treasury has surged past the 3.83% level.

At first blush, it makes sense for Treasury yields to be rising and bond prices falling during a period of economic recovery. Investors are swapping the relative safety of the bond market for the higher risk – and greater potential returns – of the stock market as the apparent U.S. recovery builds momentum.

But analysts are beginning to worry that if Treasury yields rise too much, higher borrowing costs for businesses and consumers will act as drag on housing and stocks, thus bringing an end to the rebound that has taken place over the past few months.

“Is a 10-year Treasury rate of 3.84% catastrophic? No. If it goes substantially above 4% or 4.25%, then at some point rates would be too prohibitive,” Keith Hembre, chief economist for First American Funds told CNNMoney.

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Higher yields drag on stocks because as rates rise, Treasuries – which offer less risk – become more attractive to investors. Higher interest rates can be a stumbling block for economic growth because they make it more expensive for companies and consumers to borrow, and because they put added pressure on mortgage rates.

The average 30-year fixed rate mortgage is now 5.45%, according to Bankrate.com, a Web site that tracks lending rates across the country. That’s up from 5.23% a week ago and stands as a major increase from the record low of 4.85% reached in April. These higher rates threaten to dampen home sales and discourage consumers from refinancing their mortgages.

The Mortgage Bankers Association’s index of applications to purchase a home or refinance a loan fell 16% to 658.7 in the week ended May 29, from 786 the week before. The group’s refinancing gauge plunged 24%.

In addition to threatening the housing market’s recovery, higher mortgage rates have put the U.S. Federal Reserve in a difficult position. Under more typical circumstances, the Fed would normally increase purchases of Treasuries and mortgages if it wanted to control borrowing costs.

But Federal Reserve Chairman Ben S. Bernanke has for the past several months pursued a policy of quantitative easing, and many analysts believe that’s part of the problem.

The central bank said in March that it would purchase $300 billion in long-term Treasury notes in an effort to keep rates low. It also lowered its benchmark Federal Funds rate to a range of 0%-0.25%. But instead of reducing rates, the Fed has only really succeeded in driving investors out of the market.

The Fed’s decision “is having the opposite of the desired effect,” Robert Arnott, chairman of Research Affiliates, told the San Francisco Chronicle. “People figure, if the Fed is buying Treasuries, I ought to be selling them.”

However, other analysts assert that the decision by the Fed to not accelerate its purchases of mortgages is the main reason why rates continue to increase.

“The fact that the Fed has not come in and supported the ‘national mortgage rate,’ that has gotten the market spooked,” Walt Schmidt, a mortgage-bond strategist at FTN Financial Group, told Bloomberg News.

In either case, the Fed is probably won’t take any action until the next meeting of the policymaking Federal Open Market Committee (FOMC), which takes place June 23-24.

“The Fed wants to operate in predictable ways,” Jim Bianco, president of Chicago-based Bianco Research LLC told Bloomberg. “They are also trying to not just look arbitrary, which makes people think ‘I can’t ever go to the bathroom because there could be a press release that the Fed changed the buybacks.’ That’s been a real concern: ‘Wow, I just went to the bathroom and lost $2 million dollars’.”

This article has been reposted from Money Morning. You can view the article on Money Morning’s investment news website here.

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