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Fed Chair Janet Yellen Shows Concern for Economy in Senate Testimony

February 11, 2016

“I’m not aware of anything that would prevent us from doing it.”

This was Janet Yellen’s response to a coming reality that 10 years ago would have been laughed out of the room.

The question: Might rates someday push into negative territory?

It’s amazing how the world has changed since December. Back then, the Fed bumped up interest rates for the first time in years. Many economists saw this as the new norm. “[The 30 Year Fixed Mortgage Rate] may hit 4.5 percent by the end of this year and then likely move up further to hit 5.5 or 6.0 percent in two or three years,” said Lawrence Yun of Forbes Magazine, a lifetime ago in August 2015.

Lawrence Yun’s prediction taught the world one thing: If the economic outlook can change like this over just a few months, there’s no reason to think Yun’s prediction can’t be back on track, or in the gutter by April. That’s why Janet Yellen said in her testimony to the Senate that the idea of negative interest rates will be strongly considered in the interest of more prudent planning, which in today’s global economy means being ready for anything and everything.

So let’s get ready. Here’s what could happen in the near future:

Rates drop below zero.

Yes. This means what it sounds like: Depositors could actually be charged to keep their money in the bank (though this would likely impact business, not individual customers), and businesses would get paid to borrow. While this is unchartered territory for the US, the Bank of Japan adopted this policy at the end of January, and the European Central Bank has seen negative interest rates for 1 ½  years now, which have already been utilized (or taken advantage of) by Apple, Nestle, and BP, to name a few.

Proponents of this strategy claim that negative interest rates get more money circulating by punishing banks that hoard cash instead of giving loans to businesses and smaller lenders. This in turn combats the deflation seen in several major world currencies, including the US dollar.

Opponents say that in theory, borrowing costs are decreased, but it comes with the risk of angering depositors, provoking them to pull their money from the bank and deposit it in their cupboards. This hasn’t happened in Europe because banks have not passed this fee onto their customers. However, this only means banks are absorbing the costs themselves, which in the long run could actually make lending more difficult. The jury is still out on whether this can work.

The Global Economy Stabilizes. Rates Go Up

This isn’t the trendy conversation right now, but now is the time to be prepared for the unlikely. If rates go up, it’s important to remember three things:

  1. Negative interest rates are a sign of desperation. Rate hikes are a sign of confidence. If rates start going up, it means the economy can handle it.
  2. We’ve been spoiled. The average rate of the 30 Year Fixed Mortgage Rate between 1975 and 2015 is 8.49 percent. A rate hike (when the time is right) wouldn’t bring a grand test to the economy. It would bring normalcy.
  3. There is very little correlation between mortgage rates and the Fed Funds Rate:

Screen Shot 2016-02-11 at 1.21.54 PM

What does dictate mortgage rates is the 10 Year Treasury Yield, which as seen on the chart below, is also threatening record lows 1.706%:

Screen Shot 2016-02-11 at 1.22.06 PM

What makes the 10 Year Treasury Yield such a revered tool in the mortgage industry is the fact that the most common loan is the 30 Year Fixed Rate. The average 30 year loan is typically refinanced within 10 years, making the 10 Year Treasury Yield the perfect tool to predict where rates are going. Right now they’re going down, and after recent events it feels like there is no bottom.

So is the economy strong? Is it floundering? Where is it going?

No one, including Janet Yellen, seems to know for sure. What is known is that rates are continuing to go down, which reflects a clear lack of confidence. “Financial conditions in the United States have recently become less supportive of growth,” Janet Yellen told the House Financial Services Committee on 2/10. “These developments, if they prove persistent, could weigh on the outlook for economic activity.”

It may be time to start hoping rates go up, which would be hoping for economic confidence. Strange times call for strange interests.


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