Heather Mahmood-Corley, a real estate agent, was seeing good demand for homes in the Phoenix area just a few weeks ago. But as mortgage rates rise again, she’s already watching potential homebuyers pull away.
“A lot of people are nervous,” said Ms. Mahmood-Corley, a Redfin agent who has been selling homes for more than eight years.
Mortgage rates and other key borrowing costs have risen sharply since mid-summer, adding to a rise that has already occurred in response to the Federal Reserve’s interest rate moves since the start of 2022.
The recent rise in interest rates began in financial markets and is partly due to economic growth proving much stronger than expected. This has led investors to believe that the Fed may need to keep interest rates high for longer to contain the crisis.
Even after a year and a half of the Fed’s campaign to slow the economy, the American economy remains surprisingly strong. Employers added 336,000 jobs last month, well more than the 170,000 economists had predicted, underscoring how solid the labor market remains.
But the recent rise in longer-term interest rates could impact markets and slow the strength of the real economy. Higher interest rates – and particularly rising yields on the key 10-year Treasury note – are making it more expensive to finance a car purchase, expand a business or borrow for a home. They have already caused problems in the heavily indebted tech industry and roiled commercial real estate markets.
The mounting pressure is partly a sign that Fed policy is working: Since early last year, officials have raised borrowing costs precisely because they want to curb inflation by making it harder to borrow and spend. It sometimes takes a while for their policy adjustments to drive up borrowing costs for consumers and businesses, but they are clearly having an impact now.
Still, there is a risk that rising interest rates in key areas of the financial markets will inadvertently drag down the economy rather than gently cooling it. As consumers continue to spend, the housing market slows without a decline, and businesses have continued to invest so far, there is a risk that interest rates will reach a tipping point where much of this activity will come to a halt. It could be even less predictable that something goes wrong in the financial markets.
“At this point, the rise in Treasury yields and the tightening itself are not enough to derail the economic expansion,” said Daleep Singh, chief global economist at PGIM Fixed Income. However, he noted that higher bond yields – especially if sustained – always bring with them the risk of financial instability.
“You never know exactly at what threshold you’re going to trigger these financial stability episodes,” he said.
While the Fed has been raising the short-term interest rate it controls for some time, longer-term interest rates — the kind that support borrowing costs paid by consumers and businesses — have been slower to respond. But in early August, the yield on the 10-year Treasury note began an inexorable rise to levels last seen in 2007.
The latest move is most likely a confluence of several factors. Resilient growth is one of them. Demand for government bonds is also lower as global central banks focus on fighting inflation and are no longer buying securities to stimulate growth. Some strategists say the move reflects growing concerns about the sustainability of the national debt.
“It’s all kinds of things, but it’s not a single factor either,” said Gennadiy Goldberg, head of interest rate strategy at TD Securities. “But if the increase lasts longer, everyone will be nervous.”
Whatever the causes, the jump is likely to have consequences.
Higher interest rates have already caused some financial turmoil this year. Silicon Valley Bank and several other regional lenders collapsed after failing to protect their balance sheets from higher borrowing costs, leading customers to withdraw their money.
Policymakers continue to monitor banks for signs of stress, particularly related to the commercial real estate market. Many regional lenders are tied to office, hotel and other commercial borrowers, and as interest rates rise, so do the costs of financing and maintaining the properties, and so does the amount they must earn to turn a profit. Higher rates make such properties less valuable.
“As the 10-year Treasury yield rises, commercial real estate concerns are increasing,” said Jill Cetina, deputy managing director at Moody’s Investors Service.
Even if the rate hike doesn’t lead to a bank or market explosion, it could cool demand. Higher interest rates could make it more expensive for everyone – homebuyers, businesses, cities – to borrow money for purchases and expansions. Many companies have yet to refinance debt incurred when interest rates were significantly lower, so the impact of these higher interest rates has not yet been fully felt.
“This 10-year Treasury note is a global benchmark for borrowing,” said Greg McBride, chief financial analyst at Bankrate.com. “It’s certainly relevant to homeowners in the U.S., but it’s also relevant to businesses, municipalities and other governments looking to borrow in the capital markets.”
For the Fed, the shift in long-term interest rates could indicate that its monetary policy framework is closer to, or perhaps even at, a level high enough to ensure a further slowing of the economy.
Officials have raised interest rates to between 5 and 5.25 percent and signaled they could agree to another quarter-point hike this year. But markets see less than a one in three chance that they will make that final adjustment.
Mary Daly, president of the Federal Reserve Bank of San Francisco, said markets were doing some of the Fed’s work for her: On Thursday she said the recent move in longer-term interest rates was “roughly equivalent” to another rate hike by the Fed.
Still, there are questions about whether the rise in interest rates will continue. Some analysts say there could be more room for a rise as investors have yet to fully accept the Fed’s own forecasts for how long they expect interest rates to remain elevated. Others are less sure.
“I think we’re at the end of this tantrum,” Mr. Singh said, noting that the rise in Treasury yields will worsen the growth outlook and prompt the Fed itself to back away from higher interest rates.
“One of the reasons I think this move goes overboard is that it is self-limiting,” he said.
Many people hope that borrowing costs will stabilize soon. This also applies to the real estate market, where mortgage rates are at 8 percent, up from less than 3 percent in 2021.
In Arizona, Ms. Mahmood-Corley sees some buyers pushing for two-year deals that make their early mortgage payments more manageable — betting that interest rates will be lower afterward and they can refinance. Others are staying on the sidelines, hoping that borrowing costs will fall.
“People are taking forever to make a decision now,” she said. “They’re holding back.”
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