The recent jump in the 10-year treasury rate is concerning for several reasons. First, it is an indication that demand for U.S. debt is weakening. This makes sense because we keep selling trillions of dollars of new, additional debt to fund the massive, repeated rounds of stimulus. Since the U.S. government does not have the money to fund the stimulus, they have to sell bonds to raise that money. The national debt is at crisis levels. It was already at crisis levels before Covid-19, and now it is its own pandemic. We cannot simply look at the U.S. debt in a vacuum. We depend on other countries and people and institutions in those countries to buy our debt. If they decide they will no longer take the risk of buying our debt, we will not be able to service our debt, and we will default. At the least, if demand continues to weaken, we will be forced to offer increasing interest rates on our debt to entice investors to purchase our bonds.
The second issue, which Powell discussed today, is inflation. Rates will go up one way or another, either because investors sell bonds because they know rates will increase, or because the Fed begins raising rates to combat inflation, or some combination of the two. Rising rates will help slow inflation, but the cost is more expensive borrowing, which translates to less economic activity. It will be very difficult for the Fed to control the rise in rates, balancing on the one hand curtailing inflation, and on the other, avoiding a recession.
A third negative consequence of rising rates in the impact this will have on real estate. I have seen many studies on the real estate market, and there doesn’t seem to be a direct correlation between rising interest rates and falling real estate prices. However, mortgage rates a priced off of the 10-year treasury rate. One of the key drivers of the boom we have had in real estate since the financial crisis has been historically low mortgage rates. If that driver goes away – if mortgage rates are no longer historically low – it stands to reason that the real estate market will, at minimum, cool off a bit, and possibly could go into a prolonged decline.
Many investors today have never known anything other than a bull market for stocks, real estate, bonds, precious metals, cryptocurrencies, art, collectibles, and virtually every other asset class. It will be interesting to see how this new generation of investors deals with adversity, should these various markets weaken due to rising interest rates.