Rising Interest Rates, Falling Consumer Spending…

Looks like yet another down day for bonds, which means another up day for interest rates. The sharpest climb in long-term interest rates in US history is continuing, from about 3.2% to about 4.5% in just two months. (See chart below of the yield on the 10 year government bond — the interest rate is in tenths of a percentage point.) I’ll make a prediction here: these higher interest rates are going to put a significant damper on consumer spending, and thus potentially the entire recovery, by next spring.

Just one reason why this is going to seriously slow consumer spending is because this increase in interest rates has meant the end of the refinancing boom. (See CNN/Money article.)

According to the back of my envelope, somewhere in the neighborhood of 8 to 10 million mortgages were refinanced over the past 18 months or so. Average equity taken out during refinancing is around $20,000 — which which means the average refinancer gets a cool $20k of pocket money to spend. This means that the refinancing boom has injected somewhere in the neighborhood of $160bn – $200bn into the economy over the past year or two. That’s more than the huge Bush tax cuts have put into the economy – a truly massive stimulus. With the recent rise in interest rates, that stimulus is now over. The question is whether the economy can now keep going without that stimulus to consumer spending.

By the way, what’s the cause of this rapid rise in interest rates? Part of it is expectations of faster economic growth next year. But I think a large part of it is the growing realization in the bond market that the US government is going to be borrowing at record levels for the foreseeable future. With so many new bonds flooding the market over the next 3 to 5 years, of course traders are going to price them down, thus driving up interest rates. Whatever the Bushies say, budget deficits DO cause higher interest rates.