Where Rates Are Headed Now
Some of the most frequent questions I’m asked of late are directed towards interest rates: Where are rates headed? Should I lock in my mortgage or keep it variable?
Predicting interest rate movements is much easier now than it was ten years ago. Congressional testimony by Greenspan, hundreds of bank and brokerage economists analyzing the financial statistics, Federal-fund futures contracts, and the bond market itself are all useful in helping forecast the direction of interest rates.
Right now, the Federal-funds rate of 1% is at a 46-year low. Interest-rate futures contracts are pricing in a 50% chance we will see a quarter-percent rise in rates this June. Longer-term futures contracts are more conclusively betting interest rates will rise to 2% by the end of this year, with the first Fed tightening coming in August.
I’m a big fan of watching the bond market as an indication of where interest rates are headed. If interest rates are to rise ahead, you can usually tell by falling bond prices. Conversely, if rates are to fall, bonds usually move higher in price. Hence, bond investors have done quite well since interest rates started their big decline in the early 1980s.
After the better-than-expected U.S. job figures came out for March, bond prices tanked. Friday past, the popular U.S. two- year note yield stood at 2.23%, up from 2% only a weak earlier. This is the highest level since August 27, 2002. The strong action of the U.S. dollar has also discounted a rise in rates. (In Canada, the opposite is happening. The weakness of the Canadian dollar looks like it’s discounting a decline in rates, not an increase).
So there you have it. Unless things change, the market is telling us the U.S. Federal-funds rate could rise to about 2% by the end of the year, with the first rate increase coming in August. Is it a good time to lock in interest rates if you have a mortgage? I would think, “Yes.”
What remains to be seen is how higher rates will affect the consumers’ appetite for taking on more debt. Increasing interest rates by one-percent means an extra $2,000 a year for a $200,000 mortgage-not a very big number. But the recent action of real estate stocks is telling us a different story. The price of new home builder stocks have formed a major top. Maybe the market knows something about the future demand of new homes we don’t.