Welcome back to the Mortgage Rundown. Today we are going to talk about what's happening with interest rates.
As you’ve seen over the past month interest rates have gone up over 40bps and there has been a lot of volatility in the stock market as well. It might feel like there is no end to the rise in interest rates as they are now up almost 75bps since July.
Recall the Fed raised interest rates 3 times in 2017 and is expected to raise rates three more times in 2018. You combine that with the passage of the Trump tax cuts and it created an environment very bullish for stocks and very bearish for bonds. What has happened in the stock and bond markets was very predictable.
In the past 12 months, major stock indices are up at least 25-30% without any sort of correction. This week however has been a very different story with stocks dropping 8-10% from their highs and the volatility intraday at its highest level in the past three years. However, it’s important to take a step back and look at the broader market historically that even with the recent downturn the Dow Jones Industrial Average is still up 40% over the past 2 years.
As far as rates are concerned take a look at the following graph which shows the 10yr Treasury over the past 25 years. This has become a very popular chart for some analysts to show that the 10yr has broken through the long-term trend line in red and therefore rates are going to rise rapidly. This simply is not the case. First off you can draw a trend line just about wherever you want and pick whatever time period you want. In terms of breaking the trend, the answer is 'absolutely yes'. Interest rates are no longer continuing to fall, that trend is very likely over. But that doesn’t mean they are going to rise back to levels not seen in decades.
It’s important to remember that inflation is still very low and we are not in an environment of rising interest rates. What you may and likely will see however is volatility. Remember that one of the big drivers of the stock market has been low-interest rates. Low bond yields generally chase investors into the stock market. With bond yields rising, money will likely flow from stocks to bonds, which will keep bond yields from rising further. With the 10yr near 2.80% today it’s still very possible that it can move up to 3.0% but I wouldn’t bet it will rise much higher.
In the coming weeks you should keep an eye on the following items:
1. What will be the new range on the 10yr (perhaps 2.60 to 3.00%)
2. More inflation data, will it catapult rates higher or ground them back below 2.50%
3. And last, the impact of tax reform and how much will it impact the economy.