As US homebuyers scrutinize and debate the rise in mortgage rates Federal Reserve In the next step, an even bigger story has unfolded on global stock exchanges, one that has a direct impact on Americans’ wallets.
Last month, global bond markets found themselves in the grip of a historic sell-off triggered by a tangle of complex economic issues ranging from the ongoing war in Iran to rising deficits to the race to build artificial intelligence data centers.
While it may seem at first glance that the high finance industry is far removed from homebuyers’ affordability hurdles and rising monthly mortgage payments, these market movements are a key factor affecting housing costs.
Note that the Federal Reserve does not directly set mortgage rates. Instead, the central bank controls the overnight lending rate for lending between commercial banks, while mortgage rates are set by the free market.
Mortgage rates closely follow the 10-year Treasury yield, which moves in response to inflation signals and other signals about financial conditions. Ongoing war-related oil shocks, which saw Brent crude exceed $100 a barrel, have stoked global inflation fears this year.
The 10-year Treasury yield, or the interest rate paid to bondholders, has risen sharply in recent weeks, hitting a new two-decade high of 5.36% this week, up from 4.67% in August.
Meanwhile, Freddie Mac’s average interest rate on 30-year fixed-term home loans rose from 6.66% to 7.4% in about a month.
Senior Economist at Realtor.com® Jake Krimmel finds that for a buyer with a $2,000 monthly payment budget, the difference amounts to about $19,000 less house, highlighting the real impact of financial markets on homebuyers’ finances.
Jay HatfieldCEO at Infrastructure capital management in New York City believes that global oil shortages and resulting inflation are the cause of rising interest rates.
“Even though people talk about (AI) hyperscale spending and the federal budget deficit, everything that existed two weeks before the 10-year target was 4%, so that’s the main driver,” Hatfield tells Realtor.com.
Bond prices and yields move in opposite directions. When bonds are sold en masse and their prices fall, yields rise. Inflation is a key factor in the bond market because inflation can erase gains from fixed income investments and cause investors to demand higher returns.
Oil supply disruptions have stoked inflation concerns around the world and prompted frightened investors to sell bonds at levels not seen in years.
As a result, bond yields rose, particularly in France, where the 10-year yield rose to its highest level since 2002. Similar historic declines were recorded in the United Kingdom and Italy. Due to the strong interconnectedness of global financial markets, the European panic quickly spread to the USA
But high oil prices and geopolitical tensions are not the only culprits: exploding national debt and rising deficits continue to be the silent force driving this global sell-off.
The role of government debt and deficits
Major world powers are running shockingly large budget deficits that are increasing their national debts, with the U.S. national debt exceeding $40 trillion and some European nations’ debt-to-GDP ratios at or above 100%.
As governments continue to run large deficits, they are forced to issue new government bonds. When the supply of bonds exceeds natural market demand, prices fall and yields rise to attract investors. In some cases, this can lead to a vicious cycle in which rising interest rates increase deficits and force even more bond issuance.
A case in point is France, where a lack of currency sovereignty, sluggish economic growth and political paralysis increase the long-term risk of a sovereign debt crisis, analysts say.
France’s public debt is approaching 120% of GDP, while its budget deficit remains one of the largest in Europe. After early elections in 2024, the French Parliament was deeply divided and was unable to pass meaningful spending cuts.
Investors are skeptical that next year’s presidential election will result in the implementation of necessary spending cuts or tax increases, adding to fears of a possible government default.
While some analysts have raised the specter of a similar debt spiral in the United States, Hatfield argues that it is a far greater concern abroad.
“In the US, this is extremely unlikely because economic growth is strong and debt to GDP is stable,” he notes. “Europe is much worse. France has the highest yields in the euro zone. France has gone off the rails and I would keep an eye on that.”
Hatfield is optimistic that the U.S., unlike eurozone economies, can “grow out of our problem,” although he doesn’t expect the federal government to achieve a balanced budget any time soon.
Spending on AI also plays a role
Then there is also the question of how massive spending on artificial intelligence could impact global and domestic bond markets.
Hyperscalers and tech giants like Amazon, Alphabet and Meta have issued corporate bonds to finance new data centers.
This essentially forces investors with a limited amount of capital to choose between these blue-chip corporate bonds and U.S. Treasury bonds, putting pressure on the government to increase yields to remain competitive and attract buyers.
However, Hatfield downplays the impact of AI investments on interest rates, pointing out that the AI boom existed before the war with Iran broke out in February.
“Everyone wants to blame AI for every problem in the world,” he says.
What the future brings
Krimmel argues that consumers will have to get used to higher 10-year returns.
“There are already structural factors driving yields higher, including expectations about growth and future spending in an AI-driven economy, a resulting higher neutral interest rate and increased competition for capital,” he says.
In addition, the market must contend with other inflationary pressures such as recurring global supply shocks and more uncertain domestic fiscal conditions.
Hatfield is even more explicit on this point, predicting a recession for the US housing market.
“We are already in a housing recession and expect it to get significantly worse,” he argues.
Analysts and traders believe the current bond market turmoil could get worse before it gets better, which could lead to higher mortgage rates for the foreseeable future.