Restricted Room for Higher Rates
By Scott Minerd
January 7, 2013
Interest rates should rise through 2013, however, the level to which they can increase will be limited by the Federal Reserve’s ongoing attempt to stimulate activity in the housing market.
“As the U.S. economy continues to expand in 2013, long-term interest rates should continue to rise from their present levels. There appears to be a cap, however, on how much rates will be able to rise in the near-term.
Given the adverse effect of a rising interest rate environment on the housing market, the Federal Reserve will almost certainly seek to keep long-term rates at a modest level for the foreseeable future. As a result, it would be difficult to conceive of the 10-year note rising above 2.25% within the next few years.
Although an increase to 2.25% may not seem significant, that is more than 20% higher than what the 10-year note is currently yielding. Concerning the effect of rising rates on economic activity, credit spreads are likely to continue to tighten despite any rises in rates, meaning the impact of rates backing up will be fairly muted.”
Economic Data Releases
Solid Employment and Housing Data Overshadowed by Fiscal Cliff Concern
Recent labor market data was encouraging, with initial jobless claims falling to 350,000 for the week ending December 22nd. This reduced the four-week moving average to a four and a half year low. Continuing claims also fell. New home sales rose 4.4% MoM in November to 377,000, while pending home sales rose 1.7%, both reaching the highest levels since April 2010. However, the positive employment and housing data did not translate to an improved consumer sentiment, as the December Conference Board Consumer Confidence dropped for a second month to 65.1, likely reflecting concern over the Fiscal Cliff. The December ISM manufacturing index rose more than expected to 50.7 from a three-year low in November, with improvements in regional manufacturing indices in Chicago and Milwaukee.
European Manufacturing Continues to Contract, China Growth Accelerating
The December Eurozone Manufacturing PMI fell to 46.1 from 46.3, the 17th straight month of contraction. Manufacturing PMIs across Europe were mixed. The PMI in Italy increased to 46.7, while the PMI in Spain fell from 45.3 to 44.6. Germany's PMI also fell in December while France’s PMI remained unchanged. The PMI in the U.K. surprised to the upside with an expansionary reading of 51.4, the fastest growth in 15 months. In France, real GDP in 3Q was revised down to 0.1% QoQ, with consumer confidence rising for the first time in four months in December. Data in China was solid, with industrial profits rising 3.0% YoY in the first eleven months of 2012. Both official and HSBC readings of China's PMI showed continued expansion in China’s manufacturing activities in December. In Japan, retail trade was flat from October to November, and industrial production fell 1.7% in the same period, reaching the lowest level since April 2011.
Chart of the Week
Changes in Interest Rates and Home Mortgage Applications (1990 â Present)
Mortgage applications have historically been highly sensitive to changes in interest rates. The chart below highlights the relationship between changes in U.S. 10-year Treasury yields and home mortgage applications. Typically, periods of rising interest rates hamper mortgage applications, and consequently reduce the volume of home sales. Given this relationship and the Fed’s emphasis on supporting the U.S. housing sector, it appears unlikely the Fed will allow interest rates to rise materially in the near-term.
Source: Mortgage Bankers Association, Bloomberg, Guggenheim Investments. Data as of 4Q2012.
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