It’s a Small World After All
Today we live in a global economy, an interconnected world where goods and capital move freely at lightning speed across countries. The widely accepted view is that globalization not only benefits all countries across the world but lends itself towards the betterment of the economy as a whole.
As we have seen, globalization can also have a negative impact with a domino effect in times of turmoil and unrest. This impact affects the financial markets both in the U.S. and abroad.
Flight to Safety
This geopolitical unrest can create a buying binge, which helps Bond prices improve. And when Bond prices improve, so do home loan rates. However, there are growing concerns that trump the disturbing news coming from the Middle East, which will be the guiding force of home loan rates in the times ahead. What might that be?
Inflation, Inflation, Inflation
The People’s Bank of China has raised interest rates a couple of times, most recently by 0.25% in an effort to head off a continued rise in consumer prices in China. The culprits? Soaring food prices and higher raw material costs lead the pack.
China has also tightened lending standards by requiring banks to raise their capital reserve requirements. In their latest reporting, China’s inflation rose by 4.9% year over year. This was lower than their expectations, however it still marked their highest reading in a couple of years. China may have to tighten their belt some more.
Brazil is appearing on the scene with the hottest rates of inflation in six years. They are attributing this to a rise in food costs and increased bus fares. It is anticipated the Central Bank will raise the benchmark interest rate in March for a second straight time in an effort to contain the spike in inflation.
The British are grappling with inflation as well. Their year over year reading struck a hot 4%, which is twice the rate of the Central Bank’s target. The UK has yet to address this with rate hikes because their economy is in such bad shape that any hike would make matters worse.
Inflation is beginning to become a problem in Europe where it has risen to 2.4%. This is super hot and well above the European Central Bank’s (ECB) comfort zone of beneath 2%.
With an inflation problem in Europe, the ECB will eventually have to raise rates to fight it. When they do, the Euro will strengthen against the dollar, making European Bonds relatively more attractive than U.S. Bonds. This attraction will likely put a damper on U.S. Bond purchases, and could also cause home loan rates to rise.
Many of these countries within Europe have a high number of union workers. They could very well demand pay increases to offset the higher cost of living resulting from inflation. This would exacerbate matters.
As we see signs of inflation around the world, the U.S. isn’t immune. With the second round of Quantitative Easing, known as QE2, the Federal Reserve’s stated goal is to boost Stock prices, create inflation, and lower the unemployment rate. These are all unfriendly to Bonds and could also cause home loan rates to move higher. As the old trading saying goes, “Don’t Fight the Fed.” It’s a bit like the Golden Rule, “He with the gold, rules.” If the Fed wants to accomplish these goals at the expense of Bonds, they probably will.
Some Good News
These are very interesting times. Historically speaking, rates are still extremely attractive and remain close to the historic lows…but for how long? Overall, as a percentage of total income, the cost of owning a home is less expensive that it’s been at any time since 1963. So if you or someone you know has been thinking about purchasing or refinancing a home, now is the time to get started!