Will 30-year Rates Hit 3.5%?

There’s been a lot of talk about rates coming down even further. Ben Bernanke is going to be trading our short-term holdings in debt instruments for riskier long-term holdings. An article headline in The New York Times last week actually put it this way: “Fed Will Shift Debt Holdings to Lift Growth.” They have such confidence in their plans, don’t they? We’ll get back to that.

In the article, the one nod to free-market realities was that “Bond investors already had driven down interest rates in expectation of the Fed’s announcement . . .” The market immediately prices in all knowable information as soon as it knows it. Markets are extremely efficient. We’ll get back to that idea too.

But there are still two relevant questions: 1. Will the $400 billion in short-term holdings shifted to long-term holdings cause long-term interest rates to decline further? And 2. Will it stimulate growth in the economy?

First, the rates. There is no way to know for sure if rates will come down further. The interest yields are still a function of the price of the bonds that are for sale. If rates are to come down to a TRUE 3.5% on 30-year mortgages, then the 2.5% coupon bond will have to sell for over $100. That means investors will have to agree to invest money in bonds for a guaranteed $0 return and in some cases even a small loss. China, Wall Street, corporations and the US government will all need to be buying these bonds like never before. But just because they are for sale, does not mean there will be buyers.

Add to this the fact that inflation as measured by the Consumer Price Index has been on the rise for the past 14 months straight. Inflation is the enemy of long-term interest rates. The Feds very efforts to reduce rates have created inflation which is the enemy of rates.

Will Apple or China or Wall Street investors invest in a long bond that guarantees a 0% return over a long period of time, especially when the price of goods promises to be higher in the future due to inflation? They may for a short period of time, but I would not want to be one of them and I would not bet they do it for long.

If you’re getting a mortgage right now and you’re not into gambling, lock in your rate if the deal makes sense. If you can get 4.25% on a $200,000 30-year mortgage and you currently pay 6%, then you are saving over $3000 every year. Don’t wait around too long for lower rates. They may never come and you could lose the opportunity by waiting. Doing so is gambling with $3000 on the table trying to win just a little more. If rates went down another 1/2% to 3.75% you would gain LESS THAN another $1000 per year. But remember you could lose the yearly $3000 that is sitting on the table by waiting.

Don’t gamble – lock.

Now for the second and more important question: Will this short-to-long trade stimulate the economy?


Consider the following:

1. Previous attempts to stimulate the economy through monetary and debt policy have failed. Notice that I did not say “some attempts” or that they had lack luster results. They have failed to create growth in the ecomony. We are three years into the Fed’s plan of reducing the short-term rate and purchasing bonds through QE1 and QE2. No discernable positive difference in the economy exists today.

2. We now have more debt than we did before, leading to higher tax rates and higher prices through inflation, both of which will slow real future growth.

3. Inflation (again, as measured by the CPI) is higher. We will all pay more to live in the future. But know this truth: the poorest in our country pay the biggest percentage of this bill because they pay a higher percentage of their income in food, gas, energy, and normal goods, all of which have seen recent—and will see future—price increases as a result. We have got to stop these bad policies.

These actions will not raise housing prices. They will not curb inflation. They will not stop deflation. They will not make Steve Jobs come back to Apple or Warren Buffett start telling the truth about how much his secretary pays in taxes. They will not help. Remember, markets are VERY efficient. The government, on the other hand, is VERY inefficient.

Here’s the TAKE HOME for today: The Fed’s latest tactic will not work to stimulate THE economy. But if you can save money by refinancing your mortgage, you should do it now since you will surely pay higher prices for other goods later.



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