The 30-year Treasury hit a 19-year high, touching 5.323% and closing just below 5.3% Tuesday. This adds pressure to already high mortgage rates.
The 30-year Treasury reaching 5.323% means that investors want a higher return for their money from the government for 30 years, showing their inflation worries but also their concerns about the amount of Treasury debt being issued.
Inflation is at 3.4% and they’re worried that it’ll rise. They need a higher return on their money if they’re locking it away for 30 years. This is going to cause Treasury prices to fall and yields to rise.
Now, the 10-year treasury is particularly important because it’s used as a benchmark for long-term borrowing.
The mortgage rate equation is similar to this:
10-year treasury yield + mortgage spread
So if the 10-year goes from 4.0% to 4.7%, mortgage rates can rise even if the Fed sits on its hands.
Long-term rates are determined more by the bond market and less by the Fed.
The Fed primarily controls the Federal funds rate, which is the overnight interest rate.
This means that the Fed funds rate can go down while the 10-year and 30-year treasuries simultaneously increase.
The Fed can cut short-term rates to stimulate the economy, but investors can also become more worried about long-term inflation, government borrowing, or Treasury supply, causing long-term yields to rise.
Rising inflation concerns lead investors demanding higher nominal yields to compensate.
Inflation went from 2.4% in January to 3.4% in July. People are starting to think inflation won’t reverse anytime soon.
Another issue is the federal deficit. July’s deficit totaled $432.3 billion, which may lead the government to issue more bonds. If they do this, investors will demand higher yields to absorb all the additional supply.
The national debt so far this year is around $1.2 trillion.
Now, The Oil Issue
If the Iran war continues to push oil prices higher , it’s going to lead to higher gasoline prices, which will in turn lead to higher inflation.
But not only is today’s inflation an issue, investors are looking at future inflation.
People feel that this isn’t a temporary oil spike, higher energy prices will keep inflation elevated.
This will lead them to demanding higher yields on long-term bonds.
Iran tensions will increase oil prices, leading to rising inflation expectations where investors will demand higher bond yields, which will raise mortgage rates.
This would all happen without the Fed having to raise rates.
Higher long-term rates make borrowing more expensive, which will increase mortgage rates.
Not only will mortgage rates increase, but business expansion slows down. Companies would have to finance expansions, acquisitions, equipment, factories, and other expenditures themselves.
The Fed could potentially be in a situation where it wants to lower short-term rates, but the bond market won’t corporate.
If the Fed cuts rates and economic growth weakens while inflation remaining around 3.4%, then investors worry about future inflation which leads the 10-year/30-year bond yields to remain high, making borrowing can mortgage rates to stay high as well.
Monetary policy can potentially become less effective. The Fed can control the front end of the yield curve more directly than the long end.
