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Economist Ray Perryman says a Fed rate hike shouldn't slow mortgage market


The Federal Reserve's Federal Open Market Committee is widely expected to raise the short-term interest rate several times in 2016, but the movement on longer-term mortgage rates is less clear. Ray Perryman, a professor of economics and president of the Waco, Texas-based Perryman Group, explained the factors that influence longer-term rates and the potential impact on the housing and mortgage markets.  

What are the factors that influence long-term interest rates.

Ray PerrymanThere are a lot of factors that come into play. The overall health of the economy is certainly one thing that comes into play [and] the way people interact in the investment community. For example,  when people think stocks are not a good investment and move into bonds, that drives the price of bonds up and drives the interest rate down. Another important one, though not defining like a lot of people think, is the Federal Reserve action. The rise in short-term rates can have some impact on long-term rates because it basically raises the cost of borrowing. On the other hand, there is a very important factor that comes into play here, where short-term rates and long-term rates interact sometimes, and that is future inflationary expectations.  It is a simple concept. If I am going to lend you money for 10 years, and I think inflation is going to go up two or three points, I am going to have to add that to my interest rate to keep my purchasing power the same. If I think in the long term there is going to be inflation, then I have to raise my interest rate on long-term investments.

Let’s assume that the Federal Reserve will raise the short-term rate several times over the next year. Will long-term rates necessarily move in lockstep?

It certainly will not rise in lockstep. If you look at the economy right now and analyze it based on what we have seen historically, if the Fed raises rates by about 1 percent over the next year or so, I would expect variable-rate mortgages would probably go up about a half a percent and fixed-rate mortgages will probably go up about 0.2 percent or 0.25  percent. It is not a one-to-one correspondence, but there is some relationship. You are affecting the lender’s cost of money.  

What are the factors influencing the Fed right now?

We have been through an unprecedented period of very low, zero-interest rates for a long time. The Fed is facing a dilemma because of what happened back in 2008 and the amount of reserves they had to put in the system [when they tried to] stimulate the economy with quantitative easing. The Fed has a very fat balance sheet at the moment. They have a lot of bonds on their balance sheet. Basically when the Federal Reserve is influencing monetary policy, what they are doing at the end of the day is buying and selling bonds. When they put a lot of money in the system, they do that by buying bonds and paying money that was not in the system before. That is how you maintain very low interest rates. The Fed needs to bring that back in order, to a more normal rational level. They face kind of a Goldilocks situation. If they do it too quickly and raise rates too much,  they will choke off the economic recovery and cause dislocations in housing and other factors. If they don’t do it rapidly enough, we are going to get in that situation where we have very rapid growth and a lot of money in circulation. That is going to drive inflationary pressure which, in turn, will bid up long-term rates. What they are trying to do is not-too-slow, not-too-fast, but just right.

What impact will a rising interest rate environment have on the housing and mortgage markets?

All the things that it takes for the housing market to do well are moving in the right direction. As long as they don’t choke off the recovery, then I don’t think you will see a huge impact. You will see mortgage rates rise some, but not a tremendous amount. If you look at [current mortgage rates, the 10-year bond rates, a modest rise in the short-term federal funds rate and historical tracking], the average mortgage will go up in this country by $26 a month. That is certainly an amount that is in people’s budgets that they have to consider, but it is not the kind of thing that has a dramatic effect on people’s budgets and their willingness to buy a home.

Where do you think the key long-term fixed rate will be at the end of next year?

You are likely to see the fixed rates, which have been hovering somewhere around 4 percent and even lower recently, maybe go from 3.9 [percent] to 4.1 or 4.2 [percent], assuming this is an orderly increase. I would think it would go up maybe 30 basis points. Again, it is a noticeable amount. It certainly will impact a few people at the margins. But you have far more people coming into the market if the economy does remain strong and robust, and inflationary fears out there subside. We have had a very good situation with low commodity prices, particularly oil and gas, that has given some flexibility to this situation. We have an opportunity to continue some economic growth and have fairly low inflation. If we can do that in an orderly interest-rate environment, on the whole, the benefits to the housing market will more than offset any damage from an increase in rates. 


 

Questions? Contact at (425) 984-6017 or victorw@scotsmanguide.com.

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