“Davidson” submits:
Looking at the long-term relationship between the 10yr Treasury vs 30yr Mortgage rates which are generally considered in lockstep, shows they tend to track closely with Mtg rates on average 1.75% higher (labeled as the ~1.75% Benchmark in the chart). The history from Aug 1976 thru Aug 1987 (large bracket) is a period of rapid rate rise. The most interesting aspect of this chart is that the Difference between the 30yr Mtg rate minus the 10yr Treasury rate rises when there is a rapid rise in Mtg rates. In other words, the 30yr Mtg rate leads and the 10yr Treasury rate follows with a lag during rapid rate rises.
Mtg Bankers raise and lower rates as they perceive the Real rate of return they need to achieve. The 30yr Mtg rate generally follows the formula:
% inflation + 3% Real return + x% premium = 30yr Mtg% range
The 3% Real rate of return concept roughly matches the Real GDP average over decades. The premium is adjusted by the perceived credit worthiness of the borrower but heavily influenced by the economic risk profile perceived at the time, which is usually wrong. Knut Wicksell identified in 1898 that a long-term ‘Natural Rate’ for investors operated over multiple business cycles.
Today, with rates rising and Mtg rates already at 7.5% range (small bracket), it is the institutional buyers of Treasuries who are out of sync with the rest of the market and need to catch up. Currently, there is an 88% expectation of lower rates in the near term by institutions per the recent Bank of America Fund Manager Survey. They remain rooted in expecting a recession.
The economy is already operating normally with rates well above Treasuries. Companies are profitably passing through inflation cost. The next recession will not occur till consumer delinquencies on credit cards and loans reach levels indicating a fragile financial system. This is when “Black Swan” can tip the system into recession. This appears 2yrs-3yrs in the future.
As the institutions adjust their return expectations, we are seeing capital moving towards companies operating profitably. Most of these companies have been ignored the last 4yrs as Momentum buyers focused almost exclusively on high tech issues perceived to do well under COVID lockdown. As capital continues to shift to equities, the 10yr Treasury rate will rise with the rise in equities.
Article by Todd Sullivan, ValuePlays
