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Short Term Interest Rates Increase on Debt Default Fears

Short Term Interest Rates Increase on Debt Default Fears

Since the third week of September, short term interest rates on bonds have been heading sharply higher but unfortunately, CD rates and other deposit rates haven't moved much higher. We won't see higher interest rates on certificates of deposits and other deposit accounts until the Federal Open Market Committee (FOMC) increases the federal funds rate, which isn't expected to happen until sometime in 2014.

Interest Rates Moved Higher the Past Month

First it was the threat of a government shutdown, in which we are now in day 15 of the shutdown, driving rates higher. Then the possibility of the U.S. defaulting on its debt for the first time in history added to the increase in rates. The threat of default has had the greatest impact on driving interest rates higher on short term bonds.

1 month bond rates have been affected the most the past month, moving from zero percent one day in late September to 0.27 percent on Wednesday. Yesterday there were finally positive signs of hope that the Democrats and Republicans would avoid a debt default and possibly open the government early next week.

Possible Debt Ceiling Deal Hasn't Lowered Interest Rates Yet

The positive news so far hasn't forced interest rates lower. 1 month bond rates decreased only 2 basis points on the news, closing at 0.25 percent on Thursday. The markets are probably waiting until a deal is actually reached and finalized.

The deal that is being circulated is a short term deal, probably only 6 weeks which could be another reason why interest rates haven't fallen on the news. Putting off another a fight for 6 weeks just to revisit the same issues again isn't calming the markets. Even if Obamacare is off the table, there are still fundamental differences between Republicans and Democrats on the role of the government.

Mortgage Rates Have Fallen the Past Month

While short term bond rates have skyrocketed the past month, long term bond rates have actually fallen. This is positive news for mortgage rates which are tied to long term bond yields. The housing market is still recovering and any sharp rise in mortgage rates will kill the recovery.

We already had a sharp run-up in mortgage rates over the summer on fears the FOMC would stop buying long term bonds and mortgage-backed securities. When the FOMC decided to continue their purchases, mortgage rates started moving lower.

Future Direction of CD Rates and Mortgage Rates

First lets break this down to two categories, short term direction and long term direction of interest rates. Over the next few months, short term interest rates will still be held hostage by what happens in Washington D.C.  What will likely happen is that deals will be reached on the debt limit and continuing resolution to fund the government.

These developments will send short term bond rates lower from current levels. CD rates, savings rates, and money market rates which haven't moved higher during the past month will remain near current levels. Right now the best CD rates on 3 month certificates of deposit are at 0.45 percent. The highest CD rates on 1 year certificates of deposit are at 1.10 percent.

Mortgage rates today on 30 year conforming loans are averaging 4.27 percent will fall from current levels. The direction of mortgage rates are less dependent on what comes out of Washington and more dependent on what the FOMC does. Markets still believe the FOMC will start tapering their purchases and any hint of this actually happening will send mortgage rates higher.

30 year conforming mortgage rates could fall back below 4.00 percent in the coming months if the FOMC doesn't taper. If the FOMC does slow or stop their purchases, average mortgage rates on 30 year conforming loans will soar back above 5.00 percent.

Author: Brian McKay
October 15th, 2013