Will Surging Interest Rates Zap the Economy?
September 6, 2013
Ron DeLegge, Editor
How high can interest rates go? As Jackie Gleason might say, “Straight to the moon, Alice!”
For sure, the housing market is already feeling the pain of higher interest rates and the affordability of homes, especially new homes (NYSEARCA:ITB) is being pushed to its outer limits. (See "The One Housing Indicator You Shouldn't Ignore")
Mortgage applications (NYSEARCA:MBB) for new homes have fallen 15% while mortgage refinancing have plunged 63% since May. Also, the average rate for a 30-year fixed-rate mortgage is up almost 1.2% to 4.57%.
A slowdown in the housing market is especially problematic because the broader U.S. economy has leaned so heavily on housing for support.
During the first quarter of 2013, residential investment contributed almost one-third of a percentage point (0.31%) to GDP. If a rebounding housing market has boosted economic activity and GDP that much, what will a souring housing market portend?
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A Trillion Dollar Headache
Higher interest rates and excessive debt is always recipe for disaster. And the student loan marketplace is ripe for mayhem.
Currently, there’s over $1 trillion in outstanding student loans, which after mortgages, is the next largest source of household debt. By comparison, student loans were just $240 billion a decade ago.
In a clear sign of trouble ahead, JPMorgan Chase (NYSE:JPM) is pulling out of the student loan business in October, according to Reuters
Surging interest rates will increase student loan defaults and already $8 billion of private student loans have defaulted, according to the Consumer Finance Protection Bureau.
Perspective on Rates
The chart below gives us some historical point of reference about interest rates. It shows the yield spread (or difference) between 10-year Treasury yields (NYSEARCA:IEF) and the Federal Funds Rate (FFR).
You’ll notice how the yield spread between both benchmarks has never been more than 400 basis points or 4%. And today, with 10-year yields now around 2.90% and the FFR between zero and 0.25%, the 10-year yield would need to shoot up to 4.25% to break historical records. That leaves a potential 1.35% upside in 10-year yields, should the FFR hold steady and should rate relationships stay within their historical limits.
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