Mortgage Rates Could Rise as Borrowing Costs Increase at Euro Banks

Thusfar, the debt crisis in Europe has been beneficial to borrowers in the United States. Risk averse investors have sought safety in U.S. Treasury bonds, causing bond yields to drop.  As a result, mortgage rates are at their 2010 low, and are moving closer to their historical low point.  The average rate on a 30-year fixed rate mortgage was 4.84 percent last week.  However, the other shoe may soon drop, and Americans could see higher borrowing costs.

The London Interbank Offered Rate (LIBOR), is that rate that banks charge one another for short-term/overnight loans.  LIBOR hit a 10-month high yesterday as lenders show increasing reluctance to lend to European banks and are demanding a higher return due to the perceived risk of default.  The current LIBOR is just over .5 percent, up from .25 percent in March.  LIBOR is still low on a historical scale however, as it hit 4.8 percent during the banking crisis of 2008.  Some analysts are projecting that LIBOR could go to 1.5 percent or higher by the end of the year.

We should also keep an eye on the TED spread, which is a measure of the difference between the interest rates on three-month U.S. Treasuries (T-bills), and three-month Eurodollar futures contracts.  Basically, it measures what banks charge each other for loans versus what they charge the U.S. Government. The TED Spread is slowly widening, which indicates that investors are increasing nervous that banks will default on interbank loans.

An article in this morning’s Wall Street Journal illuminates the point:

“Concerns that bad debts will start to pile up as tighter fiscal policy halts economic growth in peripheral Euro-zone countries is prompting banks to preserve cash or park it with central banks, rather than lend it to their peers”.

Lastly, we should note the difference between LIBOR and two-year Treasury notes. The spread between the two is around 25 basis points right now, which means it still makes sense for banks to own treasuries.  Foreign banks have been financing much of the U.S. government debt.  If LIBOR increases enough, it will no longer make sense for banks to own short term U.S. treasury debt, and the bond market will get shellacked.

The bottom line is this: U.S. borrowing rates are extremely low now, and consumers would be wise to take advantage while they can, because there are a number of market factors that could cause us to see higher rates in the near future.