Bank Problems Drive Down Interest Rates

On March 8th Silicon Valley Bank failed. Interest rates fell. It now appears that the highs for interest rates may have been put in for this cycle. Even as the Federal Reserve raised the Federal Funds rate to 4.75%-5.00% on March 22nd, market interest rates were falling. These lower interest rates could be good news for real estate investors looking to debt markets for financing. Bank problems appear to be driving lower interest rates for borrowers.

Although potentially good news for real estate investors, for those looking to receive good interest rates on cash or cash-like deposits this may be bad news for the future. On March 7th an investor buying a 6-month Treasury bill could receive 5.3% yield. By March 24th the yield was down to 4.719% on the expectation the Fed will be forced to pullback on its plans for hiking future interest rates. With the yield on the 10-year Treasury bond at 3.372% the market clearly expects interest rates will be going lower, rather than higher over time. (See below for yield on 6-month Tbill)

Interest Rates Fall in March

Even with the Fed still increasing its rate for borrowing, market interest rates declined in March. On March 7th the 2-year Treasury note had a yield of 5.066% in yield. By March 24th the yield was down to 3.767%. Bankrate reported that the national average for 30-year fixed rate mortgages reached 7.13% on March 10th, but by March 24th was down to 6.85%. (See below for yield on 2-year Treasury Note)

Duration Rates and Risks

The bond market never believed the Federal Reserve would be able to raise interest rates and then keep rates as high as the Fed wanted. This is why the 10-year Treasury bond has been falling from its October high of 4.228%. The 10-year closed on March 24th at a yield of only 3.376% versus the 6-month Treasury Bill rate at a higher 4.719%. Many investors believe there is too much debt in the economy for the Fed to raise rates as much as it would like without creating so many problems it will be forced to cut rates. However, some expected the Fed would hike until something broke and it was forced to stop.

With the failure of Silicon Valley Bank it appears something just broke in the financial system. Worries over risks in the banking system are linked to the duration risk around longer maturity debt yielding less than shorter maturity debt. This is a sign Fed policy is out of step with market realities. In the case of Silicon Valley Bank it also created a problem that investors in savings accounts were expecting higher yields, while the longer duration bonds the bank was holding to offset its risk were yielding at lower rates than short duration securities and losing value as interest rates rose.

With the inversion in interest rates the Fed has created, where shorter-term debt is yielding more than longer-term debt, there is the fear that some banks holding too much longer-term debt securities could face solvency issues, particularly if depositors move money to higher yielding alternatives elsewhere. This type of interest rate risk is a reason why the 10-year Treasury bond yield is well below shorter-term debt and its yield has been falling since October (see below for yield on 10-year Treasury Bond).

There is no guarantee that the highs for interest rates have been put in for this cycle. However, currently this is what the market is signaling. With the collapse of Silicon Valley Bank, as well as Signature Bank and problems over others including First Republic and Credit Suisse, even the Fed is being forced to admit limits to how much it can raise rates. The median prediction currently from the Fed is for only one more quarter point hike this year to bring the Fed Funds Rate to 5%-5.25%. Interest rate markets are already moving on the expectation of the Fed nearing the end of its hiking cycle and closer to the next cutting cycle. (See below for 30-year fixed new and refinancing national mortgage rates).