Real Estate Market & Interest Rates Weekly Commentary

Weekly Commentary ~ December 15th, 2010

Thanks largely to the likelihood of passing a “tax deal,” interest rates have been climbing at a rapid clip and analysts have brought worries about rising future inflation back into the economic discussion. It may at first seem just another swing—from concerns about possible deflation to anxieties about rising inflation, and back again—but this time the worries may have some staying power.

The two central issues here are extensions of tax benefits—first to the unemployed, second to higher-income taxpayers. What is remarkable about these two central issues is that, taken together, they amplify a few worrisome possibilities for the economy’s future. Specifically, extending unemployment benefits expands the economy’s growth—a good thing but probably an inflationary thing. Further, foregoing receipt of higher taxes from wealthier citizens most likely means that we will have to auction ever more Treasury securities, also potentially inflationary.

Now, a strengthening economy and both of these measures should help the economy grow (in the short term, at the least) nearly always translates into higher inflation and, in anticipation of that, our interest rates will start to climb…as indeed they already have. Further, the likelihood of even more massive auctions of Treasury securities increases the near certainty that interest rates will rise (as demand for Treasury securities fails to fully cover the number of securities being auctioned; it’s a supply-and-demand equation).

The credit markets don’t wait until after something has happened; they react in advance of whatever their investors believe will happen. Investors have begun to worry about inflation already and they anticipate that the seeds of higher interest rates are being sown. So Treasury securities interest rates are already on the rise, and they may continue to rise for as long as the tax deal is in place—or until something else captures the attention of traders, investors and economists.

It is difficult to predict what, if anything, will grab the real estate markets’ attention, so it seems relatively likely that the rising interest rate trend will be with us for quite some time. However, the bond guru Bill Gross of PIMCO Securities placed a $5.5 million bet on municipal bonds a few days ago. He apparently feels bond prices have fallen quite far and are likely to recover. (Bond yields decline as bond prices rise.)

The takeaway here is that while rates are clearly on the rise and could continue to rise, the economy is still reacting to external forces; to government programs and legislation; and, not to forces inherent to the current economy itself.