The 10-year yield briefly hit the 5% mark. It is the first time it has been this high since 2007. And we know what happened after 2007.
The higher yields across the board are positive for those who want a safe vehicle to park their cash. You can actually earn a positive real rate of return if you use the CPI as a measure. The yields are currently higher than the official consumer price inflation rate, which is just below 4%.
The higher yields are also needed to help bring down price inflation. The Fed created this mess by creating trillions of dollars in new money and forcing interest rates to near zero. We are all now paying for this “free” money. You have to wonder how many people would give back some of those direct checks handed out by the federal government a few years ago in exchange for lower prices at the grocery store.
Many Americans received checks multiple times in 2020 and 2021. But those were relatively short-lived. Most people go to the grocery store every week, and those high prices aren’t going away. If anything, they are still rising, even if at a slower pace.
While higher food prices have hit virtually all Americans, there is a much bigger disparity when it comes to shelter. Rents have gone higher. The cost of owning a home has gone higher, even for those who already bought a house and locked in an interest rate on the mortgage. Repairs, maintenance, insurance, and property taxes have gone up for most people.
But there is no question that those who don’t own a property (or didn’t until recently) are getting hit the hardest with higher housing prices in most areas, along with much higher interest rates.
The Cost of a Mortgage
Mortgage interest rates are closely tied to the 10-year yield. So it is no surprise that mortgage rates have also gone up. This week, the typical rate on a 30-year fixed rate mortgage hit 8%. They went as low as about 3% just a couple of years ago.
As noted by Kelly Evans of CNBC, the mortgage payment on a $400,000 house with 20% down has gone up by about $1,000 from a couple of years ago.
It is quite a stunning difference, especially for middle class America. A $320,000 loan (80% of $400,000) at 8% is $2,348 per month. A $320,000 loan at 3% is $1,349.
That is not only a difference of about $1,000, but it is about 74% higher. And the sad thing is that a $400,000 house in some big cities won’t get you much.
This is why it is unsustainable. Something has to give. If rates don’t come down soon, then housing prices will. They may come down anyway even if rates do drop from here.
Even though many houses are being kept off the market because people are keeping their low fixed interest rate, there is still going to be some activity with housing. Some people die. Some people have to move for a job. Some people just want to move. And there are always buyers out there at some price.
Most average Americans can’t afford a typical house these days given their income and the higher interest rates. Even in the example above, that assumed a 20% down payment. Most people don’t have $80,000 or anything close to it unless they are selling another house.
This is why so many young adults are living with their parents or renting apartments with roommates. There is absolutely nothing wrong with this, and in fact I encourage people to have roommates when they are young in order to save money. But at some point, people want to move out and be on their own. It is becoming exceedingly difficult to do so in today’s world with an average income, or even an income that is a little bit better than average.
Will a Recession Help?
Recessions are quite painful. They are like the hangover after a night of drinking. The best solution to a hangover is to not drink so much the night before. The drinking makes the hangover inevitable.
We actually need a recession because it is a correction of the previous malinvestment. Resources need to be reallocated in accordance with consumer demand. This is painful because unemployment can go up as different jobs need to be filled. It is also painful because many asset prices deflate. This could include housing.
If you are someone in your 20s and currently rent, you should be cheering on a recession (quietly). You need a major drop in housing prices in order to enter the market, if that is what you wish to do. It will also be an opportunity to buy investment assets at a discount, or at least a lot lower than where they currently sit. Of course, this could be an opportunity for someone of any age.
Just as higher yields/ interest rates hurt some people and help some people, so too does a recession. If you are not in heavy debt, have some cash on the sidelines, and are looking to buy assets, then a recession could actually be quite beneficial. If you are heavy in debt and don’t have much money, then a recession could be quite devastating, or at least very uncomfortable for your standard of living.
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