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.
Chart 1
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).
Chart 2
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
Econtrarian,
LLC
1-920-818-0236
Senior
Economic and Investment Adviser to Legacy Private Trust Co. of Neenah, WI
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