U.S. Dollar & Mortgage Rates

Q1: What's happening with interest rates and why should I care?

One of the knock-on effects of the current conflict is the increase in interest rates. But not all interest rates are the same, and it's important to understand which one we're talking about.

The two-year government bond rate jumped from around 3.4% before the conflict began to 4% just a few days ago. This matters because the two-year rate is seen as a predictor of the Federal Reserve's future interest rate policy. A jump of this magnitude means the bond market switched from expecting future rate cuts to potential rate hikes. That's a significant shift in expectations.

The ten-year government bond rate is probably the most widely tracked interest rate in the world. It has major implications for everything from mortgage rates to the stock market. The rule of thumb: we don't want to see it move too quickly in either direction. If it's rising too fast, the market is likely bracing for an inflationary environment. If it's falling too fast, it could mean a recession is on the horizon. Right now, it's climbing uncomfortably fast but has yet to reach what I would call "escape velocity."

Q2: What's happening with the U.S. Dollar?

Remember last month when I discussed the dawning of a new cycle of dollar weakness? A lot has changed in the last month. After a highly publicized demise, the Dollar tapped into its inner Mark Twain and said, "Those reports have been greatly exaggerated."

We learned that the Dollar is still viewed as a safe haven during times of crisis. Don't take my word for it—take the market's. Relative to other major currencies, the Dollar recently reached its highest level in almost a year.

Similar to interest rates, I would prefer a subdued Dollar. No sudden movements, please.

Q3: How is the housing market being affected by all this?

"With mortgage rates where they are, we feel stuck." That was from a conversation I had with a friend, but honestly, it's a common refrain among Americans these days.

The ten-year government bond rate matters enormously for mortgage rates. Sales of existing homes have hovered around post-housing bubble levels in absolute terms for the past two years. Relative to the overall housing supply, we are at an all-time low.

High mortgage rates have a two-pronged effect. First, they make home purchases more expensive for renters trying to buy. Second, they keep current homeowners "trapped" with their existing 3-4% mortgages—why sell and give up that low rate to take on a new mortgage at 7%?

Q4: Why does the housing market matter for the broader economy?

Housing's impact on the economy is multifaceted. Rents are consuming the highest percentage of disposable income in history. The National Association of Realtors estimates $90,000 of transaction-linked spending for each home sale—that's money that doesn't flow through the economy when people aren't moving. Job-related mobility is constrained, keeping home-owning workers in their current locations rather than allowing them to take higher-paying, better jobs elsewhere. And property taxes are suppressed, impacting local governments.

For all these reasons, a lower interest rate on the ten-year government bond would be a welcome sign for the housing market.

Q5: What's the bottom line on all this?

There is a lot at stake in the Middle East right now, way beyond financial markets. For many reasons, we hope for a swift end to this conflict. In the meantime, keep your eyes on the two-year and ten-year interest rates, and on the U.S. Dollar. These indicators will tell us whether markets are starting to breathe easier—or bracing for more turbulence ahead.