Buckle up for a sustained rise in interest rates: analysis

10-year Treasury note has nearly doubled in 18 months. If it breaks 3%, expect mortgages to hit 5%.

Start with “how high, how fast.” The Fed is determined to defend its 2 percent inflation target. The Fed can get behind and have to catch up, a prescription for up-fast too-high, and back-down-fast. The 10-year maybe to 4 percent briefly, mortgages pressing 6 percent, followed by a refi party.

The other side of the high-probability bracket is continuing “normalization,” the Fed in search of the “neutral policy rate known as r* (pronounced “ar-star”) defined as the Fed funds rate spread above inflation which is neither stimulative nor a drag.

The Fed does not know the location of r*, in part because it moves. In the 1970s to offset oil and inflexibility, r* might have been a 4 percent premium above inflation — and the Fed’s flinch from that altitude encouraged the deadly spiral. Just last year Yellen mused that r* might now be zero — a normalized Fed funds rate might be the rate of inflation itself.

Given all of the inflation-suppressants in place, guess r* to be at 1 percent, which is what the Fed is doing with its damned-little-dot scattergram of future intentions. Two- or three-year target for Fed funds: 3 percent. But then a secondary unknown: what will be the response of long-term rates to that level of Fed funds? If inflation stops at 2 percent, and the Fed stays tough, the 10-year might not get above 3.5 percent or even so high, mortgages mid-fives. Normalized.

If that happens, somebody on Wall Street might say something nice about the Fed.


The 10-year T-note in the last five years, everyone in markets staring at the 3.00 percent double-top at the end of 2013:

The Fed-sensitive 2-year T-note, same five years showing two things: how vastly variable long-term rates are versus the Fed, and the stall in the last two weeks hints that markets are ahead of themselves in both Fed- and inflation-fear:

The National Federation of Independent Business has surveyed its members since 1974, one of the longest useful series on the US economy. All following charts are NFIB, apologies for inconsistent format. Since ’74 the NFIB surveys have been an excellent real-time indicator of the US economy — until Election Day 2016 when it departed the economy for politics. Its membership is heavily right-side, which is fine and normal, but our economic-political relationship today is not normal, unusual experiments underway. The election spike in optimism could not be more plain:

The underlying survey components tell a different story, worth watching. Last month “optimism” reached an all-time high — not at all reflected by survey components. “Earnings” are the one happy spike, and with the tax bill giveaway to businesses, one would hope so. But, does that change indicate a shift in the real economy?

This is the “sales” component. Yes, there’s a nice jump in “actual” (bold line) in 2017, but nothing fancy compared to the 2012 spurt, and still tepid compared to 1974-2006:

“Prices” are still a falling trend. “Compensation” is rising steadily, and if it breaks above the long-term trend, one of the best inflation-precursor indicators:

Question asked and answered. No:

Lou Barnes is a mortgage broker based in Boulder, Colorado.

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