Higher Rates Won’t Sink Home Sales

Most of the increase in interest rates is behind us, though inflation fears still lurk.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

June 11, 2009

Long-term interest rates will continue to edge higher, spurred by hopes that an economic recovery is taking shape as well as fears that that recovery will fuel inflation. Bond buyers are already edgy over a federal budget deficit that will top 12% of gross domestic product, the highest percentage in 60 years.

The yield on the 10-year Treasury bond this week is just below 4%, up more than 1.5 percentage points since Jan. 1, with most of the increase coming in the past five weeks.

The 10-year Treasury yield will stay between 3.5% and 4% for the rest of 2009, which will hurt mortgage refinancing activity. Refinancings had been on the rise until 30-year fixed rate mortgages jumped to 5.3% from 4.8% during the past two weeks in the aftermath of a jump in long-term Treasury yields.

Home sales will slow, too, but not by much. Bargain prices, especially on foreclosed homes, continue to lure buyers. Also providing a boost is a tax credit of $8,000 for first time purchasers.

"Home buying is more than a function of just interest rates,” says John Silvia, chief economist with Wachovia Corp. “People still see tremendous bargains."

Among central bankers, the rise in Treasury yields is creating concern because Federal Reserve policymakers want rates low enough to fuel continued gains in home sales, which will help lead the economy out of recession.

Fed officials are closely monitoring an indicator called the TED spread to see if the higher yields are drying up lending and borrowing. The TED spread, which has been holding steady in recent weeks, is the difference or spread between the yield on three-month Treasury bills and the three-month Eurodollar LIBOR (London Interbank Offered Rate).

The three-month Eurodollar LIBOR is a rate that multinational banks charge on loans to each other. LIBOR is also a benchmark for lending rates on some $360 billion of loans, including residential mortgages and corporate bonds. The TED spread hit a peak of 4.6 percentage points during the financial panic last fall and has been steadily dropping. It now stands at 0.5 percentage points.

We at Kiplinger are also closely following the TED spread, as well as five other indicators, to help you spot the bottom of this recession. Click here to see our Recovery Index and sign up for e-mail updates.

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