Monday, August 19, 2013

Where to begin tonight

There are so many interesting topics to discuss - the chaos in Egypt, a Western government (UK) smashed a the hard drives of a media outlet (seriously!), radiation levels in sea water near Fukushima are at the highest level since readings have been taken (again, seriously!), the Indian Rupee is complete free fall (down nearly 20% in the past 3 mths), stocks have fallen 9 of the past 11 days, there are technical indicators that haven't popped up since 2008 that are flashing warning signals everywhere and interest rates have perked up.

Let's just focus on interest rates tonight.  Today, the 10yr treasury note touched 2.89% and this important because this is the rate upon which all other rates (mortgage, car loans, etc) are based. This interest rate has jumped 75% since May and is sitting at 2yr highs.  If the move ends here, I think it will merely be a blip on the financial radar.  If, however, this is the end of the great 30 year bull market in treasuries, we are going to have some issues to discuss.

1) Housing - consider that last year a 30 yr mortgage could be had for 3.66% which is a ridiculously low rate.  A $300,000 mortgage would have had a payment of just $1,370 or so.  Now imagine the impossible -- if this interest rate move gathers steam and mortgage rates make it all of the way back to 2000 levels of 8%.  In order to maintain that same $1,370 mortgage payment the principal of your mortgage has to go all of the way down to $185,000.  In other words, your $300k house is now worth $185k (or less) on the open market.  The ramifications of this kind of move would be broad - falling home prices, increased defaults, banks going bust AGAIN, real estate tax revaluations, budget shortfalls for schools and local governments, etc, etc.  This currently is not a likely scenario, but neither was a 75% move in 3 months for the 10 yr note so we should be aware of the possibility.

2) Treasuries as investments - An entire generation and a half has grown up knowing that treasuries only go up in value.  They are considered "safe" and not subject to traditional market risk.  This is a fallacy.  Treasuries trade just like stocks and bonds and they are priced inversely to their interest rate.  As prices fall, rates rise, but the reality is we've rarely seen this in the past thirty years.

3) The Federal Budget - The CBO was projecting 2013 10 yr rates of about 2%.  Most of our debt is short-term now but if the 10 yr rate starts increasing, short-term rates may be close behind.  We were expecting to drop about $220 billion on interest costs this year with rates at 2%.  As I mentioned, 10yr rates are now about 2.85-2.9%.  That's almost 45% higher than projected.  Would that mean $100 billion in EXTRA interest costs this year??  It's hard to say (probably not b/c the bulk of our debt is very short-term), but the implications are clear.  Anything extra spent on interest is money that can not be spent on other programs of the Federal Government.  Again, right now this isn't a huge issue because higher tax revenues are helping to reduce the deficit although it remains elevated relative to historical levels.   However, if interest rates were to hit 4-5-6% we're going to have a problem because we are basically financing our debt with a variable rate mortgage.

Well, on those happy notes go grab some sushi while still can :)

Cheers!

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