During the past two months two of the world’s leading central banks have begun the process of unwinding or, at least, tapering the quantitative easing which was first initiated after the great financial recession of 2008/2009. The Federal Reserve FOMC statement for September and their Addendum to the Policy Normalization Principles and Plans from June contain the details of the US bank’s policy change. The ECB Monetary policy decisionfrom last week explains the European position.

Whilst the Federal Reserve is reducing its balance sheet by allowing US treasury holdings to mature, the US government has already breached its debt ceiling and will need to issue new bonds. The pace of US money supply growth is unlikely to be reversed. Nonetheless, 10yr US bond yields have risen from a low of 1.35% in July 2016 to more than 2.6% earlier this year. They currently yield around 2.4%. Over the same period 2yr US bond yields have risen from 0.49% to a new high, this week, of 1.60% – their highest since October 2008.

Back in April I wrote about the anomaly in the US interest rate swaps market – US 30yr Swaps have yielded less than Treasuries since 2008 – does it matter? What is interesting to note, in relation to global real estate, is that the 10yr Swap spread over US Treasuries (which is currently negative) has remained stable at -8bp during the recent rise in yields. Normally as interest rates on government bonds declines credit spreads tighten – as rates rise these spreads widen. So far, this has not come to pass.

In the US, mortgages are, predominantly, long-term and fixed rate. US 30yr mortgage rates has also risen since July 2016 – from 2.09% to 3.18% at the end of December. Since then rates have moderated, they now stand at 2.89%, approximately 1% above US 30yr bonds. The chart below shows the spread since July 2016:-

Source: Federal Reserve Bank of St Louis

Apart from the aberration during the US presidential elections the spread between 30yr US Treasuries and 30yr Mortgages has been steadily narrowing despite the tightening of short term interest rates and the increase in yields across the maturity spectrum.

Mortgage finance costs have increased since July 2016 but by less than 50bp. What impact has this had on real estate prices? The chart below shows the S&P Case-Shiller House Price Index since 2006, the increase in mortgage rates has failed to slow the rise in prices. The year on year increase is currently running at 5.6% and forecasters predict this rate to increase to 5.8% when September data is released:-