[Wayne 962]

Just posted this on Reddit, I figured it would be entertaining for everyone here?

Let me start by saying it’s difficult to predict the future, because there are many different factors that influence markets. These factors may be absolutely true, but what many people don’t realize is that it’s difficult to measure what I call “Scope and Scale”. Example: you can pee in the ocean and it will technically raise the level of the ocean up a infinitesimally small amount. The melting of ice shelves also raise the level of the ocean, but their impact is much greater. This is an extreme example that I use just to make a point. People who say “peeing in the ocean is raising the level” and “melting ice caps are raising the ocean” – they both are right, but one doesn’t really matter as much as the other.


That’s a good pretext to interest rates. There are a lot of different factors that influence interest rates, specifically mortgage rates for both homes and commercial properties. I personally think that rates are likely to keep going up, based upon events that are happening right now, and will happen in the near future. I have two in particular that I have been watching and I think these two will have significant “scope and scale” on the mortgage rate market.


The first one is Treasury debt. First of all, nearly everyone on the planet seems to think that Powell sets mortgage rates by changing the FED overnight lending rate, sometimes called federal funds rate. Same thing. No need to go into details on what this is exactly (see here for more info: https://www.investopedia.com/terms/o/overnightrate.asp), but people confuse this with “mortgage rates”. They are not the same. The overnight lending rate does *influence* mortgage rates but they aren’t the same. Sometimes a movement in the overnight lending rate has no or little effect on mortgage rates. Here’s another quick article that tries to explain: https://www.stlouisfed.org/in-plain-english/the-fed-implements-monetary-policy


Anyways, the mortgage market is considered to be a “safe” investment, and by near definition, the safest market available is the US Treasury market. So, the US mortgage market almost always moves in tandem with the US Treasury market. If rates on Treasuries go up, then mortgage rates go up. Some banks specifically peg their current mortgage rates to the Treasury market. With my bank and commercial loans, it’s typically the 10-year Treasury note + a bank spread. The spread is what you negotiate on when trying to get a mortgage – the base is set by the Treasury market.


The Treasury market is an *auction* market, with rates set *solely* by people and organizations who are actively buying bonds. Pretty much like the stock market. Very, very efficient, without many dislocations. This means the price is set by supply and demand – just like many people learned in Econ 101. What happens if there are a lot of people wanting to buy US Treasurys? (yes, it’s spelled that way – that’s not a typo). The interest rate paid on the bond will go down. What happens if there’s an auction and there aren’t many people who want to buy Treasurys? Then the US Treasury (the government) will have to raise rates in order to attract more buyers. It’s very simple. The up and down of this Treasury market is what determines the prevailing mortgage rates. Not Powell and the overnight lending rate. There could be hours-long discussions on the relationship between the overnight lending rate and the US Treasury market, but that’s a discussion for another day.


So, if mortgage rates closely track the Treasury market, and the Treasury market is solely determined by supply and demand, then people who want to try to predict interest rates should probably look to the supply and demand that will be occurring in the near term. Cutting to the chase, the US Treasury (the government) will be issuing a record amount of US debt in the remaining half of this year. This will cause a supply increase. Without a corresponding increase in buyers (typically the Chinese, Japanese, etc.) then the US government will have to offer a higher rate in order to attract more buyers. More info on this here: https://fortune.com/2023/07/31/how-big-federal-debt-deficit-treasury-bonds-auction-markets/ (sorry if behind a paywall).


I might add a little note here on who some buyers of Treasury debt are – the Chinese. Why would the Chinese buy US Treasury debt? The answer is simple – they make stuff, we buy the stuff, and we pay them in dollars. Theoretically, dollars are only useful for stuff in the US (the home country). Since the dollar is considered a reserve currency the world over, that’s not necessarily true, but for the sake of this discussion, we’ll assume that payment in US dollars means that they have to buy “stuff” with those dollars. Since we have a trade imbalance with China, we give them a lot more dollars (basically IOUs in our currency) for the stuff that we buy in Walmart, the iPhones, and other Chinese goods, etc. With all of this trade, the easiest thing to do with the US dollars is to turn around and buy US Treasuries. I think they own about a trillion of the bonds right now. Anyways, bottom line on this – as purchases from China are scaled back (for many reasons), the corresponding demand for US Treasuries goes down. Ironically, the more stuff we buy from China, the more that they will want to buy US Treasurys, which will keep the rates down.


So – A wave of Treasury debt is coming, and it’s unknown what the demand will be for that debt. If demand is light, then they will have to raise rates to attract new buyers.


Second point – banks. Without going into intense detail (I can do that in a follow-up reply), many banks these days are suffering from not-so-good assets on their loan books. Just look at all of the office properties being handed back to banks - Exhibit A. I few months ago, I called several banks that my good friends have great relationships with. My friends said “Call my guy ‘Joe’ at XYZ bank – he’ll hook you up”. So I did. All of them said, “we’re not lending right now”, or “we’re only lending to people who have an existing relationship with us.” Wow, it doesn’t take a PhD from MIT to figure out that if the banks aren’t really keen on lending right now, then they (or their competitors) will be more picky. More picky means higher credit requirements *and* the ability to charge a higher rate. If you go to five banks and four say “we’re not really lending right now” the fifth bank can pretty much charge what it wants to lend the money (within reason, of course). I have seen this driving up interest rates already (this would be the spread I mentioned previously – placed on top of the baseline Fed Funds rate).


Anyways, there you have it. These are just my thoughts on the influences affecting interest rates today. It’s nearly impossible to predict demand for Treasuries and impossible to predict the bank’s appetite for new loans, but one can certainly see factors that would affect those two both positively and negatively. When rates were at 3%, I told everyone that I thought they would normalize at about 7.5% - about what they were in the early 2000s. Most people thought I was Chicken Little, but better safe than sorry. Now I think they are poised to go higher, at least in the short term, due to at least these two factors I mentioned here. I certainly could be wrong and these two factors could be negated by something else. But that’s what the discussion is all about?


Cheers…

https://www.reddit.com/r/CommercialRealEstate/comments/1696zyw/lets_have_a_frank_discussion_on_interest_rates/