Why Rising Mortgage Rates Matter For The U.S. Recovery

Economy recessionAs long-term rates have climbed in recent months, mortgage rates have followed suit. The cost of a 30-year conventional mortgage is now at about 4.7%, up from 3.6% in early May, and the monthly mortgage payment on a median US house has increased roughly $200 during the same period.

As mortgage costs have risen, mortgage and sales activities have started to drop. Arecent MBA survey has loan activity down by more than 50% from a May peak and July new home sales plunged, experiencing the biggest drop in 3 years. But rising rates may not just hurt the housing market, they could also hurt the US recovery through their impact on the housing market.

As I write in my new weekly commentary, the housing market is critical for the US recovery. When bond yields fell somewhat last week following news of the 13.4% drop in July new home sales, the importance of the housing market to the recovery was tacitly acknowledged (a weaker housing market implies a weaker economy and a less aggressive Federal Reserve).

If steeply rising rates cause the housing market to roll over, the economy is likely to go with it. Housing drives new construction. And perhaps more importantly, recent higher home prices have been supporting consumer confidence and consumption. Even in the absence of disposable income growth, consumers have been more inclined to spend as their paper wealth has increased along with rising housing prices, a phenomenon known as “the wealth effect.” Confidence and consumption could suffer, however, if housing prices decrease along with a housing market suffering from quickly rising rates.

The good news is that I expect that interest rates, and mortgage rates by proxy, will continue to increase at only a modest pace. The Fed knows that the recovery is still tepid, and higher rates will slow it further. In addition, the majority of a near-term adjustment in rates ahead of a likely fall taper has already taken place.

But there is the risk of rates rising faster than I expect.

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