Yield Curve Flattening: What Does This Mean For The Real Estate Market?

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Update:

Mortgage Rates Jump to 7-Year Highs May 15 2018, 4:02PM
Mortgage rates spiked in a big way today, bringing some lenders to the highest levels in nearly 7 years (you’d need to go back to July 2011 to see worse). That heavy-hitting headline is largely due to the fact that rates were already fairly close to 7-year highs, although today did cover quite a bit more distance than other recent “bad days.” (Source)

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Any impact from rising short-term interest rates on the real estate market can be tied into a larger question: Is the yield curve signaling economic weakness on the horizon?

While a vibrant real estate market is critical to the strength of the U.S. economy, Federal Reserve tightening has moved 3-month to 10-year yields higher making the cost of financing for prospective buyers (or mortgage refinancers) more expensive.

Couple this with a dearth of housing stock available for sale pushing prices higher in many cities around the country and some prospective homebuyers are being priced out of the purchase market.

“The worsening inventory crunch through the first three months of the year inflicted even more upward pressure on home prices in a majority of markets,” NAR Chief Economist Lawrence Yun said. “Following the same trend over the last couple of years, a strengthening job market and income gains are not being met by meaningful sales gains because of unrelenting supply and affordability headwinds.” (Source)

Is The Yield Curve Predicting An Economic Slowdown?

While the Federal Reserve is able to control the level of short-term interest rates through fed funds, the long-end of the yield curve is generally a function of inflation expectations and/or economic strength expectations.

While the Fed has raised the fed funds rate and is expected to do so 2 to 3 more times this year, inflation remains tame and economic growth despite the federal tax cuts has not yet risen to the consistent 3%+ GDP growth built into many models.

If the 30-year treasury yield remains the same, moderately rises or falls in the face of higher short-term yields, we get what is know as a flattening yield curve. Were short-term yields to be higher than long-term yields known as inversion, it has historically signaled a recession.

Yield curve steepness is typically quoted as the yield differential between 30-year and 3-month maturities.

Reasons for a Flattening Curve
A flattening yield curve may be a result of long-term interest rates falling more than short-term interest rates or short-term rates increasing more than long-term rates. A flat yield curve is typically an indication investors and traders are worried about the macroeconomic outlook. One reason the yield curve may flatten is market participants may be expecting inflation to decrease or the Federal Reserve to raise the federal funds rate in the near term.

What is an ‘Inverted Yield Curve’
An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession. (Source)

The 2017 Yield Curve (‘Flattening Treasury Yield Curve And Recession: This Time Is Different?‘)

Maturity          1/3/2017          12/28/2017

3 month              .52%                   1.27%
1-year                  .89%                   1.62%
5-year                1.94%                   2.13%
10-year              2.45%                   2.37%
30-year             3.04%                   2.76%

At the start of 2017 the yield curve steepness 3-month to 30-year was 252 basis points and by the end of the year it was down to 149 basis points. (Source)

The May 2018 Yield Curve (Source)

Today the yield curve 3-month to 30-year has flattened further to 123 basis points, but the oft-quoted 2-year to 10-year yield spread is 47 basis points.

Conclusion

While it’s too early to tell if any serious risk of recession is on the horizon, for investors as well as for homeowners and prospective home buyers the treasury yield curve is most definitely something to keep an eye on. At the very least, it can provide a warning sign from bond investors that economic weakness may be in the cards over the near or medium-term.

Michael Haltman, President
Hallmark Abstract Service
Email: mhaltman@hallmarkabstractllc.com
Phone: (646) 741-6101

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