Here we go again! Rates are on the rise.
Last week, Federal Reserve Chairman Ben Bernanke, hinted that they may reduce their program of buying U.S. $85 billion of bonds every month.
What does this mean?
Well, many or almost all of the banks and lenders loan and mortgage portfolios are directly based on the bond market pricing. Lenders borrow their funds from the bond market to price their loans.
With the U.S. treasury pumping $85 billion directly into those markets, they are directly affecting the pricing of loans and mortgages.
It’s a simple demand versus supply strategy.
To stimulate the economy consumers need a reason, and they also need confidence that they are buying at the right time.
So with the U.S. treasury buying all of these bonds, this does two things.
First, they are lowering the cost of the bonds by purchasing a large portion of that market, thus decreasing the demand for them. This then decreases the yields (another fancy word for profit) making it very unattractive to the investing market, making them invest directly into the stock market where the gains may be larger. This means that investors will invest more in the stock market as opposed to the safe bond market.
Second, with this decreased yield on the bond, mortgage lenders and banks have access to an extremely cheap funding source for their mortgages, thus the super low interest rates we’ve been having.
When the economy turns the proverbial corner, consumer confidence returns as jobs return, and with great news, the U.S. treasury can look at decreasing its exposure to the bond market.
When there’s good news, economists and heads of state bankers can ease off of the gas pedal in funding the markets. Essentially, these low prices are a falsehood as it is the government that has provided the stimulus thus creating stimulus for the economy, once they remove their pressure from the bond market as the economy recovers fully on its own, then we will see interest rates rise to where the market directly affects the pricing as opposed to government intervention.
As long as the U.S. economy keeps moving along into positive economic territory, then we‘ll see interest rates rise even further. This could be the end of this low interest rate ride. We’ve been saying it for years that it wasn’t going to last forever, and it might just be coming to a head.
Jean-Guy Turcotte is an Accredited Mortgage Professional with Dominion Lending Centres Regional Mortgage Group.