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tightening in order to quell inflationary pressures. The increase in interest
rates would depress the business and consumer sectors, which caused inventories to build and companies to lay off employees. Those recessions
typically ended once the inventory was worked off and pent-up demand
had a chance to build.
Recoveries after asset bubbles are fundamentally different, in that the
problem isn’t a surplus of inventory, but a surplus of bad debt from the
bubble years. This takes a much longer time to work off, because it is a
function of the legal system and time. In addition, the concomitant loss of
confidence becomes a “wall of worry” that takes time to break down.
This confidence problem is evident in the lack of housing starts, despite a
shortage of housing. Builders are reluctant to buy land and smaller bankers
are reluctant to lend to developers. This translates into mediocre economic
growth and “lower for longer” interest rates.
We have seen this before — in Japan. The lesson from Japan is that interest rates don’t rise as quickly as central bankers might prefer. The Bank
of Japan has tried to get off the zero mark twice since the bubble burst,
and both times had to reverse course. In fact, short-term rates are still at
record lows. Although the circumstances between the U.S. and Japan are
different, the characteristics of post-bubble recoveries remain the same.
One final factor to consider is the Fed’s status on quantitative easing (QE)
and the state of their balance sheet. The Fed has increased the size of its
balance sheet from about $800 billion to $4.5 trillion by purchasing Treasury
bonds and mortgage-backed securities (MBS).
Since the end of QE, the Fed has maintained its assets at the $4.5 tril-
lion level by re-investing maturing proceeds back into the market. In 2016,
The Fed purchased over $380 billion in MBS as total mortgage originations
came close to $2 trillion.
Recently, however, there has been discussion by Fed officials about shrinking its balance sheet by allowing maturing securities to run off. As the Fed
moves in that direction, a major source of demand for mortgage-backed
securities will disappear, which intuitively should have a negative impact on
If you look closely at the data, however, you see that there doesn’t appear to be a meaningful change in the spread between Treasury yields and
mortgage rates during QE years. Prior to the Great Recession, the spread
between the 30-year fixed-rate mortgage and the 10-year bond was pretty
constant at around 1.66 percent, and that didn’t change significantly when
the Fed was buying up mortgage-backed securities. A full exit from QE
should not have a major effect on mortgage rates either.
Overall, it is hard to predict what will happen to interest rates in 2017; however, fears that a 75 basis-point hike in the federal funds rate will translate into a 75 basis-point increase in 30-year mortgage rates are probably
overblown. If history is any guide, the yield curve will flatten as the Fed
announces rate hikes, which means long-term rates will rise slower than
short term rates.
In many respects, the 10-year bond is priced as if those hikes have already
happened. Given the Fed’s habit of overestimating future GDP growth, and
political uncertainty in Washington, we may not even see a 75 basis-point
hike in the funds rate this year. The end of the Fed’s reinvestment strategy
should not affect mortgage spreads materially, either, so 2017 might not be
the disaster in the making that many in the industry fear. n
Brent Nyitray is director of capital markets for iServe Residential Lending, a multistate residential
mortgage bank. A chartered financial analyst (CFA), Nyitray also is the author of a blog on finance,
economics and real estate called the Daily Tearsheet ( thenadtearsheet.blogspot.com). Nyitray has
a bachelor’s degree in economics and a Master of Business Administration in finance. Prior to
iServe, Nyitray was an analyst at several hedge funds. Reach him at email@example.com
or (203) 817-3614.