Hear Me Out

Interest rates are structurally set up to go higher. I mean, it is kind of hard to argue that rates will go lower when inflation is ripping 1% higher every two months.

And yet, in the short term, I think interest rates will go lower.

I used to teach finance at the university level (and will again), and the textbooks tell you that interest rates are a result of the intersection of supply and demand for loanable funds. This is a pretty good model, although it doesn’t explain everything. For example, back in the early 2010s, there was a huge amount of investment required for fracking. The energy industry borrowed hundreds of billions of dollars, which was a big demand for loanable funds, and it pushed interest rates up. Or you could consider the “wall of savings” that Boomers had, which represented a huge supply of loanable funds that pushed interest rates down.

So where are we now? Well, the economy is running hot, housing and automobile prices are skyrocketing, and people are borrowing huge amounts of money, driving up interest rates. And maybe the turn in demographics is here—maybe the Boomers are dissaving and selling stocks and bonds.

My thesis is that inflation, inflationary psychology, or whatever you want to call it, has triggered an excess demand for loanable funds.

Now, that doesn’t do much to explain something like skyrocketing mortgage rates, or does it? Here’s a nice chart:

That is one dramatic move in mortgage rates. But not unwarranted. Hard to believe mortgage rates were 2.65% just last year.