The Trade Deficit And Mortgage Rates: Should We Listen To The Doomsayers?
by Henry Savage
The Department of Commerce recently reported that the monthly U.S. trade deficit soared to an all-time high of more than $60 billion in November -- the seventh record setting month in 2004. Basically, we're buying a lot more from foreigners than we're selling to them. Imports rose to $156 billion, while exports shrank to $96 billion, creating the gap. When you look at the value of the dollar in relation to the other currencies, it just doesn't make sense. Since 2002, the dollar has been falling. A weak dollar will make imported goods expensive and U.S. made goods cheaper in foreign markets. In spite of this, the U.S. is still buying far more foreign goods than it is able to export. Some analysts are saying that November's numbers are an aberration due to the heavily volatile oil market. Perhaps they're right, but the continuing trend of a weak dollar and trade deficit is worrisome to folks like me in the mortgage business. Here's what the pessimists say: The trade deficit is keeping interest rates low. Let's say that Japan sells $1,000 worth of goods to America next month. In the same month, America sells Japan only $500 worth of goods. Japan ends up with $500 in American currency. Instead of exchanging the weak dollars, it invests the dollars into U.S. Treasury bonds. The ongoing demand from foreign investors for Treasury bonds is keeping the price of the bonds high, and the yield down. Since long-term mortgage rates are similar financial instruments, they will move in the same direction as Treasuries. So far so good -- the trade deficit is helping to keep mortgage rates down, which in turn creates a strong housing and refinance market. The doomsayers charge that the appetite for Treasury bonds in foreign markets cannot be sustained. Even though there will always some demand for American goods, foreign central banks will eventually become satiated with U.S. Treasuries. Demand will fall and a sell off will occur. Such a scenario would be ill timed. It's a classic supply/demand situation. The U.S. is flooding the market with treasury bonds in order to finance the current budget deficit. If foreign investors' demand for U.S. Treasuries drops, we would face a serious imbalance of supply and demand. Bond prices would drop and their respective yields would shoot north. Bye-bye low mortgage rates, hello recession. Still, other economists don't seem worried about such an outcome. Productivity remains high, inflation is being kept at bay, and U.S.-backed investments remain among the safest on the planet. Stay tuned, it should be an interesting year. | 
