US Mortgage rates are moving higher, despite the Fed’s 50 basis point rate cut in September, and lyrics to Thinks Are Not The Same by Marvin Gaye come to mind.
Until now, this is how it played out; the Fed would cut rates, and the 10-year treasury bond market would rally with their corresponding yields tumbling.
Exhibit One, The US 10-Year Treasury Note chart shows the 10-year yield tumbling from 4% near the peak in August to 3.6% in September triggered by the Fed’s larger-than-anticipated 50 basis point cut.
The initial first-month move in the 10-year treasury yields in the wake of September’s Fed rate cut was as predictable as water flowing downstream or the effects of gravity on a falling object.
“Until now, this is how it played out; the Fed would cut rates, and the 10-year treasury bond market would rally with their corresponding yields tumbling”
WIN INVESTING
Here is the anomaly, the 10-year treasury yields are moving higher, and so are US mortgage rates
Rising 10-year treasury yields and higher mortgage rates in a backdrop of further anticipated Fed fund rate cuts in October are not usual.
Could something be broken?
Investors are anticipating further Fed fund rate cuts, so why are they not rushing in to buy the 10-year at 4.2% today if the Fed fund rate cutting cycle could send the Fed funds to well below the current yields?
Investors are emerging from the most aggressive Fed rate tightening cycle in decades.
So, typically, in this early stage of the Fed rate-cutting cycle, you would expect to see a vibrant bull market rally in the treasury bond market.
“Investors are emerging from the most aggressive Fed rate tightening cycle in decades”
WIN INVESTING
Fed cuts, yields, mortgage rates and gold moving higher
Rising 10-year yields in a backdrop of rate cuts could underscore a market imbalance where the supply of treasuries exceeds its demand.
Gold prices rising in tandem with rising bond yields is also an anomaly.
Demand for gold, the ultimate haven asset, remains buoyant despite the opportunity cost of earning over 4% yields in treasury bonds.
Is this a paradigm shift where the safety of gold has become more appealing to investors than yielding US paper?
The post-2023 treasury bond market crash could have made bond investors nervous, and they are now seeking reassurance from the Fed not just about Fed fund rate cuts but also about the Fed’s new bond-buying programme, also known as quantitative easing QE.
Think about it.
The US Public Debt is soon 36 trillion dollars and growing exponentially, and interest payments on the debt are now the third largest budget item, nearing one trillion dollars.
Ballooning public debt also means an increased supply of treasury bonds, and if demand for US paper doesn’t keep up with the supply, bond prices fall, and yields keep heading higher.
“Short term, more QE would put a floor on the bond market, giving optimism for bond investors to pile into bonds”
– Win Investing
Imbalances in the treasury bonds market cause mortgage rates to rise
The solution is simple, we hear you say; the Fed, the buyer of last resort, steps in, with QE and buys all the surplus bonds.
But there is another factor in the equation. QE increases the money supply M2, which debases the currency, leading to monetary inflation.
Short term, more QE would put a floor on the bond market, giving optimism for bond investors to pile into bonds.
Long term, it would probably lead to more inflation.
QT would send mortgage rates higher
Quantitative tightening QT, where the Fed reduces its balance sheet, would slay any hope of a bond bull market.
The rising treasury 10-year yield would send mortgage rates even higher, hitting 6.82%, as the 10-year yield jumps to 4.20%.
In this scenario, mortgage defaults would skyrocket.
To date, the cost of servicing debt has triggered the worst car repo crisis, where auto loan delinquency rates are as high as in 2010. Current treasury bond yields impact loan rates and are a massive headwind on a highly leveraged public and private sector.
“Real estate prices are a derivative of the availability of affordable mortgage rates” – Win Investing
Fed Rate cuts, mortgage rates rising and tumbling real estate prices?
What if the Fed loses control of the treasury bond market with yields spiralling out of control because investors believe a currency crisis is looming?
Think about it. Gold has appreciated approximately 40% in 52 weeks against the USD, with treasury yields near decade highs.
Is anyone in the room surprised if an investor today prefers gold over US bonds, particularly when the government has to go further into debt to create even more dollars to service the fast-approaching one trillion dollar debt interest payment?
Creating dollars to pay the bond yields will not cut it anymore.
Value comes from scarcity.
Where is the value of something when its supply is infinite and created from nothing in a system that investors are losing trust in?
Perhaps the 2023 great bond market crash was a wake-up call, and Fed rate cuts in 2024 with mortgage rates heading higher could be evidence of a paradigm shift.
Where next, if mortgage rates keep heading higher?
Real estate prices are a derivative of the availability of affordable mortgage rates.
When mortgage rates fall, demand for residential real estate rises and vice versa.
A period of rising bond yields and mortgage rates could crush property sales. Real estate agents could be in for a rough ride.
But as explained previously, if 10-year treasury bond yields keep heading higher, that increases borrowing costs for auto loans, business loans and mortgages, bearing in mind lenders look to 10-year treasury bond yields as a yardstick for setting interest rates on loans.
So higher bond yields mean higher mortgages and more expensive credit, which is a massive headwind for an economy run on credit.
