Interest Rates No Place But Up: Installment #2

The premise of this blog is that residential lending rates are going to rise. The trigger is when Janet Yellen commences raising rates. The question is how much will they increase?

Ted’s Forecast: When Janet Yellen announces that the Fed is going to increase rates, within six months the 30-year residential fixed-rate loan will increase by 61 to 71 basis points. By 12 months rates will have risen from 110 to 119 basis points.

Analysis follows.

Freddie Mac started collecting interest rates weekly for 30-year fixed-rate loans in April 1971. The weekly rates are then averaged for a monthly statistic.

Interest rates are abnormally low today. I can recall in 1989, when closing on the house in College Station, Texas, being thrilled that the 30-year fixed-rate loan was 9.75 percent – the lowest in more than a decade at that time. In comparison, the average 30-year fixed-rate residential loan rate was 3.67 percent in April 2015 according to Freddie Mac.

Monthly residential rates have only been lower in 11 of the 529 months since data collection commenced in 1971. The following graph shows the 30-year rate for residential fixed-rate loans since 1972 with times of recession highlighted in the background. I conjecture that defining normal is pretty much impossible.

5-27-15 graph1

Other metrics of these monthly rates from April 1971 through April 2015:

  • Average rate was 8.42 percent
  • Median rate was 7.93 percent in April 1996
  • Lowest rate of 3.35 percent occurred in November and December 2012
  • Highest rate was 18.45 percent in October 1981
  • Largest six-month rise in rates was an increase of 469 basis points, going from 11.64 percent in September 1979 to 16.33 percent in April 1980
  • Biggest six-month decline was 357 basis points when rates dropped to 13.25 percent in January 1983
  • Largest 12-month increase was a gain of 583 basis points in April 1980 to 16.33 percent
  • Biggest 12-month plunge was a decline of 456 basis points in February 1983 to 13.04 percent

Since the premise is that rates are going to rise and not decline, the focus will be on historical residential rate increases, ignoring the times when rates declined.

A recent blog listed the forecasts for 2015 and 2016 by Fannie Mae, Freddie Mac and the MBA They show rates from Q3 2015 to Q3 2016 rising from 30 to 90 basis points (see the table below) or an average 63 basis points. From Q4 2015 to Q4 2016 rates are forecast by the three to increase an average 70 basis points.

5-27-15 table1

Six-Month Rate Increase

Given the infamous statement from Mark Twain, “History may not repeat itself, but it certainly does rhyme,” past changes in rates serve as perhaps the best indicator of future rates. In the 529 months of data collected by Freddie Mac, rates increased over a six-month period an average 63 basis points and a median 45 basis points. If, however, you agree with the premise that rates are abnormally low, then the increase in the first six-months of rate increases may well exceed the historical mean and median.

The following table examines the various quantiles of six-month rate increases since 1971. While I believe that rates will rise more than typically seen since 1971, I do not believe that the early 1980s rocket increase will occur. A set of three quantiles (tertiles) shows the top group rising 122 basis points as the median of the top group. The second highest group in four quantiles (quartiles) indicates a 61 basis point rise. Five quantiles (quintiles) indicates a 71.5 percent rise based on the second highest set. The six month interest rate change expectation ranges from a median 45 basis points to a high of 71.5 basis points using quintiles.

5-27-15 table2

12-Month Rate Increase

The following table is similar to the previous, but uses 12-month changes. Using the next to the highest group in both quartiles and quintiles, a forecast rate increase from 110 to 119 basis points is indicated.

5-27-15 table3

Note that the average 12-month increase of 70 basis points from Fannie-Freddie-MBA from Q4 2015 to Q4 2016 is less than the 12-month median increase of 85 basis points, but only due to Fannie Mae’s miniscule 30 basis point projection. Freddie Mac and the MBA are both at 90 basis points.

While there is not a total agreement on how high rates will rise, it is unanimous they will go up.

I’m expecting 5.2 percent by the fall of 2016.

That’s my 2 cents.


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