Interest rates are incredibly important for all markets: from the stock market to the housing market and even cryptocurrency and NFT's. They impact savers, investors, homeowners, and prospective homebuyers. Interest rates help define generations.
My grandfather bought his house with a mortgage rate of 4% in the 1960's. My Dad bought the house I grew up in Irvine for $150,000 with a mortgage rate of 13% in the early 1980's. When my wife and I bought our first house a few years ago, we paid the same rate as my grandfather, 4%. The mortgage rate directly impacts the price of the home. As rates rise home prices fall, to reduce the monthly cost to homeowners. As rates fall, home prices rise as homeowners can afford more house.
Interest rates also control the cost for Apple to borrow money in the bond market and buy back stock boosting their stock price. The attractiveness to do acquisitions is also a function of how cheaply companies can borrow. Interest rates are one of the most important factors of finance. So where are rates going in 2022?
First of all, as readers surely know, inflation has spiked for the first time since the 1970's. The latest inflation rate from December, 2020 was 7%. As a result, the Federal Reserve has begun talking about raising rates and reducing their bond purchases as part of their quantitative easing program (QE). Consequently, the bonds markets have begun shifting.
Jeffrey Gundlach of Doubline recently pointed out one way to forecast the federal funds rate is to track the yields of US Treasury 2-year bonds, which recently rose to 1%:
Another way to see what the market expects of interest rates is to track the federal funds futures market. The market currently expects the Fed to raise the federal funds rate by a quarter point at their meeting on March 16, 2022. By the end of the year, the market expects the Federal Funds rate to be between 1.00% to 1.25%, in line with Gundlach's 2-year Treasury equivalency:
The federal funds rate is important as it is the benchmark rate than impacts the financing cost for everything, especially the 10-year US Treasury bond yield, the largest driver of mortgage rates. Today, the US Treasury 10-year bond yields 1.9% over the federal funds rate. If that spread holds with a federal funds rate of 1% that would a 10-year yield of about 3%.
A 10-year yield of 3% forecasts, with 98% historical accuracy, a 30-year mortgage rate of 5%.
A $1,000,000 home with current mortgage rates of 3.75% with a 20% down payment carries a monthly mortgage of $4,800, including property taxes (using California rates). To maintain the same monthly mortgage cost at a mortgage rate of 5%, the price of the house has to fall 10% to $900,000.
Where will rates go in 2022? The odds are up. But, in 2018, the market ascribed a 0% chance the Fed would cut rates once they began raising them. And sure enough, after the stock market fell by 20%, they did:
Whatever transpires with interest rates it is sure to be market moving news. We will keep you updated here and on our podcast.