June 27, 2013
Will the Recent Rise in Interest Rates Shut Down Household Spending?
Not likely. Today, June 27, the yield on the Treasury 10-year security closed at 2.47% according to the Bloomberg public (i.e., free) website. According to the Fed, this security closed at 1.66% on May 1. All else the same, household borrowing and spending would be stronger had this interest rate not risen by 81 basis points in the space of about two months. But it is doubtful that the recent rise in bond yields of many stripes will shut down consumer borrowing and spending.
Consider Exhibit A (Chart 1), the household debt-service burden. This is a Fed-generated series of required principal and interest payments for households as a percent of their disposable personal income. The median household debt-service burden from the inception of the series, Q1:1980 through the latest available data, Q1:2013, is 11.85%. The latest reading on the debt-service burden is 10.49%, the lowest burden save for 10.32% registered in the previous quarter, Q4:2012. In terms of the debt-service burden, it would seem that households have abundant capacity to take on more debt even at higher interest rates. Bear in mind, as bond yields tend to behave pro-cyclically. That is, bond yields tend to rise as the pace of economic activity quickens and fall as the pace of economic activity slows. If this pro-cyclical behavior of bond yields persists, then the upward pressure on household debt-service burdens resulting from rising bond yields will be partially offset by rising disposable personal income. And, of course, shorter-maturity interest rates have risen by much less than bond yields recently. Nowhere is it written that households must borrow at the long end of the maturity curve.
Now consider Exhibit 2 (I am a big fan of Car Talk’s Click and Clack). Exhibit 2, which is shown in Chart 2, is a comparison of the imputed yield on owner-occupied housing vs. a mortgage rate. The imputed yield on owner-occupied housing is the imputed rent on such housing (contained in the details of the personal consumption expenditures data provided by the Bureau of Economic analysis) as a percent of the market value of owner-occupied housing (contained in financial accounts of the United States data provided by the Federal Reserve).
In Q1:2013, the imputed yield on owner-occupied housing was 6.84% compared with an effective mortgage rate of 3.56% on sales of existing homes. Thus, the imputed yield on owner-occupies housing exceeded the cost of financing said housing by 328 basis points. Since the inception of these series, Q3:1973, the median value of the imputed yield on housing minus the mortgage rate is minus 153 basis points. That is, in contrast to recent years, typically, the imputed yield on owner-occupied housing is exceeded by the cost of financing said housing. Thus, although the recent rise in the 30-year fixed mortgage rate, all else the same, makes owner-occupied housing less attractive as an investment, owner-occupied housing remains a screaming buy in an historical context.
In sum, when the talking heads of CNBC and Bloomberg tell you that the recent rise in bond yields is going to snuff out household borrowing and spending, fade ‘em!
Paul L. Kasriel
Senior Economic and Investment Adviser to Legacy Private Trust Co. of Neenah, WI