A dire narrative is gaining force in the financial and consumer markets. It’s the story of an interest-rate wrecking ball that is set to raze the economy, with the housing market being the last piece to fall.
The concern is understandable.
In the years that followed the 2008 financial crisis, the Federal Reserve’s ultra-low interest rate policy built the foundation of the bull market in real estate. But now the benchmark Treasury yield, which dictates market rates including those of mortgage loans, is higher than it was before the meltdown. The average mortgage payment was $2,605 at the end of July, up 19% from a year earlier, according to Redfin.
What’s worse, some economists and investors are saying rates may remain elevated for years to come, held aloft by persistent inflation, high energy prices and deglobalization.
The thing is, when most people talk about rising rates, real estate prices, and cyclical and secular trends, there’s one piece of context they tend not to mention.
If we zoom out – and I mean, really zoom out – we see that today’s high rates are but a shiver in what has been a tectonic shift in the other direction.
Here’s the reality: Interest rates have been falling for 600 years. Starting in Europe and then continuing for the entire history of the U.S. — this has been the megatrend that’s powered economies.
Sure, there were periods in the past six centuries in which rates rose, sometimes for years. And today’s higher rates have put a dent in home sales and prices. But there are more reasons to be bullish than bearish — including market and policy factors that should give us comfort that housing won’t repeat the cascade of devastation that occurred 15 years ago.
In the meantime, however, we would benefit from getting to know our friend, the long-term trend, a little better.
The Very Long View
During the Civil War, there was hyper-inflation, driven by huge government deficits. The Great Inflation, as the period from 1965 to 1982 was called, was propelled by monetary and fiscal policy mistakes that are nonexistent today. Fed Chairman Paul Volcker eventually broke the back of inflation in the early 1980s, and it’s been fading ever since, putting a cap on rates.
Bouts of rising rates, it turns out, always have been temporary countertrends. And, often, they were reported in nominal terms. In real terms, adjusted for inflation, they were, at times, negative, including during Volcker’s first year as head of the Fed in 1980.
There’s good reason to believe in an upper bound for interest rates. In the Bank of England’s 2020 working paper on rates stretching back to the 1300s, the author notes that capital accumulation, an increase in savings and the emergence of consumerism were the factors driving the trend as economies in Europe, and then the U.S., developed. In short, economics and modernity are intertwined.
Average real rates through time have fallen steadily, the research showed. In the 1400s, the average rate was 9.1%. For subsequent centuries, the averages were 6.1%, 4.6%, 3.5%, 3.4%, 2% and, so far in the 2000s, 1.3%. Global real rates have dropped an average of 1.59 basis points a year from 1317 to 2018.
Still, the average rate for the 2000s is much lower than today’s, whether it’s the federal funds rate (a target range of 5.25%-5.50%) or the yield on the benchmark 10-year Treasury (4.50%).
This Time It’s Different
There are four, albeit smaller, forces at work that are likely to pull down those rates.
First, the Fed has an incentive to keep rates low as U.S. debt stands at $33 trillion, up three-fold from 20 years ago. Some hedge fund investors are banking on it.
Second, from the end of 2008 to the beginning of 2022, the three Fed chairpersons followed what’s become known as a zero interest rate policy (ZIRP) to drive down unemployment to create a more equitable society. Turns out, ZIRP didn’t stoke inflation. As a result, expect ZIRP to make a reappearance to catalyze economic growth as inflation eases.
Third, lending rules that went into effect after the financial crisis ensure that banks must follow stringent standards. Interest-only loans represented almost a fifth of all mortgages in 2006, fueling home prices and, eventually, unaffordability.
Finally, millions of homeowners locked in low rates in the 2010s and through the pandemic. Today, 62% of homes carry mortgage loans that are less than 4%. Even as mortgage rates have topped 8% this year, there hasn’t been a housing crisis.
Relief Is On The Way
With low rates and plentiful jobs, Americans have been able to afford their homes. And they’re staying put, for now, reducing volatility in the residential real estate market. (Commercial real estate is another story. Remote work and companies’ cost cutting are mostly responsible for a teetering office market in large cities.)
Expect rates to fall along with inflation, reverting to the average trend for the 2000s. The consensus among economists is that both measures will do so in 2024.
So today might be a good time to buy real estate as demand is low and supply is less competitive. After all, six centuries of data have shown us that interest rates are mostly moving in one direction.
