Two pieces of important economic news happened Tuesday. The House of Representatives voted to raise federal borrowing authority, known as the debt ceiling (the Senate is expected to pass the measure.) Second, Federal Reserve Chair Janet Yellen announced that the Fed would continue to slowly relax economic stimulus.
The effects of those actions are still ricocheting around the economy, affecting everything from treasury yields (many went up) to your mortgage (still low, but went up too). Let’s unpack the economic Rube Goldberg Device and see how.
The Debt Ceiling and Treasuries
Now that the debt ceiling is all but officially raised, it's very likely the government can keep paying its bills at least for the next 13 months. So Uncle Sam isn't about to become a deadbeat. As a result, investors became a little less worried about buying one month T-bills. (One month T-bills are when you lend to the government money for a month.) It’s easy to see why – let’s say Uncle Sam had become a dead beat, he would have run out of money in about a month. So a one month treasury bill would be pretty scary.
But that didn’t happen. So, reassured, investors went back to buying one month T-bills and in doing so, they bid the price up, allowing interest rates to fall to the lowest level in three weeks.
The Fed and 10-Year Treasuries
The opposite effect happened with 10 year treasuries – which are among the most important treasuries because they are a benchmark for many other interest rates in the economy. Interest rates on ten year treasuries rose.
That’s not what happens in many other countries. If you were crisis-rocked Greece a few years ago, and you suddenly looked more stable, investors would have told you “Phew! Alright, you’re safer now, so you can lower the interest rate you’re offering and we’ll still invest with you.” But the opposite effect happened here.
To understand why, you need to understand that U.S. treasuries, in general, symbolize safety. It’s like going into a bunker or a cave to weather the end of the Mayan calendar. Even when we had debt ceiling crisis .....which could have affected treasuries, people still wanted longer term treasuries. That’s because even if Uncle Sam missed (or more likely in the case of the debt crisis not being lifted, delayed) an interest payment, long term treasuries were still safer than markets, which would have completely flipped out if Uncle Sam had defaulted.
But the news yesterday told investors that the world was a little safer for them. The House moved to raise the debt ceiling, and the Fed maintained a steady hand.
So if the world of investing looks a little safer, and the economy ten years into the future (the life of ten year treasuries) looks bright, investors won’t run to the safety of U.S. treasury notes. As a result, those notes are a little less in demand, and yields rise to compensate.
If mortgages are tied to treasury rates, does that mean my mortgage is rising too?
That’s right, they did, just a touch.
Your mortgage, like many other loans of similar maturity, is related to the yield on government securities. That’s because in a crude sense, government securities compete with your mortgage... and your car loan, and your student loan. A bank can loan to you, or it can loan to Uncle Sam.
Uncle Sam is always the safer bet. So if the returns banks get from lending to Uncle Sam go up, well, they’re going to go up for you too.
But mortgages, and treasury yields, are still lower than they have been for several months. Again, the explanation is best thought of in terms of safety. Many emerging markets over the past several months have had problems, ranging from mild to major. That has pushed investors to US bonds over the past several months, keeping yields down.