Flattening Yield Curve Worrisome As Economic Growth Slows
I feel as if I have seen this movie before. With that thought in mind, the idea that this time may be different is what makes previous patterns in markets hard to handicap. But, make no mistake, a flattening yield curve is a worrisome sign. This is especially concerning, given how hot inflation is currently running and where low-interest rates are at present. The bond market had a terrible week as 30-year mortgage rates hit near 5.000%, which is a dramatic increase from the 3.25% or so rates were at the beginning of the year. I also find it strange that the equity markets are surging on a week when bond yields have risen to levels not seen in several years. The erratic behavior of the market is one reason why it’s so difficult to both predict the future or place big investment bets in one direction or the other. Even when all signs point to an outcome, that outcome may not happen.
Take housing as an example. Given the lack of housing supply, the way in which rates will affect housing demand remains uncertain. I do expect sales to slow as the combination of very high inflation and much higher mortgage rates are not favorable. Yet, at the moment, many real estate brokers remain very busy and our office has a near-record amount of purchase volume.
One of the great joys of my job is speaking to so many people each and every week. One client who is in the online retail business informed me that as soon as gas hit $6 per gallon, the business fell off a cliff. Disposable income is getting eaten up by life’s necessities in a way unseen in over 40 years. Gas prices, food, rent, you name it, and the price is higher. There is much talk of the strong possibility of a 9%-10% CPI print. Should this happen, the Fed will need to act quickly and strongly with at least a .50 bp increase in rates and perhaps even do so sooner than their next meeting. Inflation is beginning to erode economic growth. Bond guru, Jeffrey Gundlach, said recently that he is on recession watch. He looks at the 2-10 and 5-10 Treasury spread as one of his main predictors of a recession. Should both of these spreads go negative from very flat, he fully expects a recession. A steepening yield curve will give the all-clear.
Now for the positives. One, real estate has historically been an excellent hedge against inflation. This means that should the markets swoon, investors may want the security of a hard asset such as real estate. Two, a more downbeat mood opens the door to better negotiations between buyers and sellers. As the market normalizes, there is a chance there will be more homes for sale or that sellers will be willing to work with potential buyers in ways that have not been seen over the last two years. Finally, rates are still attractive from a historical perspective (real rates are deeply are negative when measured against inflation), especially adjustable-rate mortgages (ARMs). While it seems likely the 30+ year bull market in interest rates has been broken, let’s not forget the 10 year Treasury is still only at 2.48%.