As U.S. homebuyers scrutinize rising mortgage rates and debate the Federal Reserve’s next move, an even bigger story is unfolding on global trading floors that directly affects Americans’ pocketbooks.
Over the past month, global bond markets have grappled with a historic selloff triggered by a tangle of complex economic issues ranging from the ongoing war in Iran to rising deficits to the race to build data centers to power artificial intelligence.
Although at first glance it may seem that the realm of high finance is far removed from the hurdles of buyer affordability and rising monthly mortgage payments, these market movements are a key factor influencing housing costs.
One thing to keep in mind is that the Federal Reserve does not directly set mortgage rates. Instead, the central bank controls the overnight rate for loans between commercial banks, while mortgage rates are set by the free market.
Mortgage rates closely track the 10-year Treasury yield, which moves in response to inflation signals and other signals about financial conditions. Persistent war-related oil shocks, with Brent crude surpassing $100 a barrel, have fueled fears of global inflation this year.
The 10-year Treasury yield, or interest rate paid to bondholders, has risen sharply in recent weeks, hitting a new two-decade high this week at 5.36%, up from 4.67% in August.
Meanwhile, Freddie Mac’s average rate on 30-year fixed-rate home loans increased from 6.66% to 7.4% in about a month.
Realtor.com® Senior Economist Jake Krimmel notes that the difference for a buyer with a $2,000 monthly payment budget equates to about $19,000 less for the home, highlighting the real effects of financial markets on homebuyers’ finances.
Jay HatfieldCEO of Infrastructure Capital Management in New York, sees the global oil shortage and resulting inflation as the underlying cause of rising rates.
“Even though people talk about large-scale (AI) spending and the federal budget deficit, all that existed two weeks before the 10-year mark was 4 percent, so that’s the key factor,” Hatfield told Realtor.com.
Bond prices and yields move inversely. When bonds are sold off en masse and their prices fall, yields rise. Inflation is a key factor for the bond market because it can wipe out gains from fixed-income investments, prompting investors to demand higher returns.
Oil supply disruptions have fueled inflation fears around the world, prompting frightened investors to sell bonds on a scale not seen in years.
In doing so, bond yields rose, in particular the French 10-year rate which reached its highest level since 2002. Likewise, historic routs were recorded in the United Kingdom and Italy. Due to the deep interdependence of global financial markets, the European panic quickly spread to the United States.
Yet high oil prices and geopolitical tensions are not the only culprits: Skyrocketing public debt and growing deficits continue to act as the quiet force driving this global sell-off.
The role of debt and public deficits
The world’s major powers are running incredibly high budget deficits that are adding to their national debts, with the United States’ national debt exceeding $40 trillion and some European countries’ debt-to-GDP ratios being at or above 100%.
As governments continue to run large deficits, they are forced to issue new government bonds. When the supply of bonds exceeds the natural market demand, prices fall and yields rise to attract investors. In some cases, this can create a vicious cycle in which rising interest rates worsen deficits, forcing the issuance of even more bonds.
A good example is France, where lack of monetary sovereignty, sluggish economic growth and political paralysis increase the long-term risks of a sovereign debt crisis, analysts say.
France’s public debt is approaching 120% of GDP, while its budget deficit remains one of the largest in Europe. Following the 2024 snap elections, the French Parliament was deeply divided and failed to pass significant spending cuts.
Investors are doubtful that next year’s presidential election will lead to necessary spending cuts or tax increases being implemented, helping to fuel concerns about a potential government debt default.
While some analysts raise the specter of a similar debt spiral in the United States, Hatfield says the concern is far greater abroad.
“This is extremely unlikely in the United States because economic growth is strong and the debt/GDP ratio is stable,” he notes. “Europe is much worse. France has the highest yields in the eurozone. France is unbalanced, and I would watch that.”
Hatfield is optimistic that unlike Eurozone economies, the United States can “work its way out of its problem,” although he does not foresee the federal government achieving a balanced budget in the near future.
AI spending is also a factor
There are also questions about how massive spending on artificial intelligence could affect global and domestic bond markets.
Hyperscalers and tech giants such as Amazon, Alphabet and Meta have issued corporate bonds to finance new data centers.
Essentially, this forces investors with limited capital to choose between these investment-grade corporate bonds and U.S. Treasuries, putting pressure on the government to raise yields to remain competitive and attract buyers.
However, Hatfield downplays the impact of AI investment spending on rates, recalling that the AI boom existed before the outbreak of war with Iran in February.
“Everyone wants to blame AI for all the world’s problems,” he says.
What the future holds
Krimmel says consumers will have to get used to high 10-year yields.
“There are already structural factors pushing yields higher, including expectations for future growth and spending in an AI-driven economy, a resulting higher neutral interest rate, and increased competition for capital,” he says.
Additionally, the market faces other inflationary pressures, such as continuing global supply shocks, as well as a more fragile domestic fiscal situation.
Hatfield is even more direct on this point, predicting a recession for the US residential real estate market.
“We are already in a housing recession and we expect it to get even worse,” he says.
Analysts and traders say the current bond market turmoil could get worse before it gets better, which could lead to higher mortgage rates for the foreseeable future.
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