- Mortgage rates above 7% squeeze affordability, discourage supply, and raise rollover risks.
- Consumers remain resilient, but high rates, energy costs, and weak real wages threaten credit health
- AI-linked borrowing is surging; investment-grade spreads hold while high-yield spreads are widening.
- Bond inflows reduce equity support; earnings misses or stagflation could trigger a sharp sell-off.
- A global debt crisis is unlikely, but prolonged high rates would spread economic pain worldwide.
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COMMENTARY: LIVING WITH 5%+ US BOND YIELD
A sizeable shifting of yield curves this year has the potential to affect markets and economies worldwide. Putting aside AI-driven euphoria and that sector’s seeming invulnerability to rising rates, there is a clear-cut relationship between interest rates, economic activity, and asset valuation. We explore some of these channels, with the context that past episodes of recessions and financial crises have almost always been associated with rising rates.
Housing: With 30-yr US mortgage rates heading past 7%, a level rarely seen in a quarter century, implications for the housing market are clear. Those lucky enough to lock into lower rates in recent years will not be interested in selling. Those brave enough to buy now will find the dwindling supply of homes not going down in prices. As housing prices remain sticky, affordability metrics would worsen, and mortgage-backed securities will find only few bids. This dynamic would unfold globally, and perhaps with even greater speed as a very large portion of mortgage holders outside the US have variable rate products, accentuating the imminent rollover risk.
Consumer credit: US consumers are spending robustly, with retail sales up 6%yoy through August, But the high cost of energy, high interest rates, and barely positive real wage growth will cause their financial health to weaken. Relatively low leverage and unemployment levels make an imminent worsening of consumer credit unlikely, but if rates remain high, servicing loans will become challenging in a matter of months, in our view.
Corporate borrowing: A borrowing binge is taking place both at the investment grade and high yield areas, led by funding for the AI build-up. Markets seem unworried about investment grade credit, with spreads well-anchored. But high yield spreads have begun to widen, as the combination of rising treasury rates and massive supply begin to weigh in on the sector.
Financial stability: High rates have made bonds more attractive, with flows into bond funds rising in the past two months. Equity markets are bound to see less support as a result, even if a group of AI-stocks remain well-bid. With such precarious dynamic in place, even a modest disappointment in earnings could trigger a major stock market sell-off. Additional financial stability concern stems from a stagflation scenario, in which high rates weaken activities, but Iran and Ukraine wars keep energy prices elevated, thus providing no respite to short-term inflation or policy rate expectations.
International spillover: Rising yields in the world’s largest public debt market is having major spillovers, with yield curves getting pushed up everywhere. We don’t see a global debt crisis around the corner, as liquidity is ample and bond markets continue to function well. But if rates stay in the present vicinity for a couple of more quarters, the pain would be felt far and wide.
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