Mortgage rates rose last week - with rates for a 30 year fixed mortgage climbing from 4.350% to 4.504% - echoing trends in the U.S. Treasury market, where 10 year note yields climbed to 2.78%, an eight week high.
The conventional wisdom in the financial media this morning is one of surprise. After all, wasn’t the Federal Reserve’s $600 billion stimulus package announced on Nov. 3 supposed to keep interest rates down?
The idea was to pump bond prices up and keep yields down – but that’s not what happened in the first week after the Fed’s second round of quantitative easing (the fist was $1.3 trillion poured into the mortgage backed securities market in 2009 and early 2010).
So why the bump up in interest rates? Here’s a vote for the “human” element in the bond market: Institutional investors are weighing the prospect of inflation, and see the Federal Reserve’s $600 billion stimulus gambit as a door opener for inflation. The Fed is essentially printing the stimulus cash out of thin air, and a lot of smart investors believe higher inflation is barreling down the pike. When that mindset sets in, bond prices slip and interest rates rise, and that could very well have contributed to the upward spike in mortgage rates last week.
The one piece of concrete economic news out during the week seems to bolster the inflation expectations argument. According to the U.S. Commerce Department, retail prices rose 1.2% in October, which was higher than economists expected. Most economists had expected a rise in prices of about 0.7% - the same number we saw in September. A retail price number that almost doubles that amount is indeed fuel for the inflation fire.
Another factor could be default risk. As we’ve seen across the pond, economies in places like Ireland and Greece are teetering on the brink of full-on default. When bond investors view their investments as an elevated risk, they’re less likely to buy bonds, causing prices to fall and rates to rise. Some economists are whispering about the possibility of default here in the U.S., where the national debt has risen $3 trillion in the past two years. As with Europe, if U.S. bond market investors raise their eyebrows over that debt, the bond market will tend to lose some investors.