As of mid-February 2018, the Dow Jones Industrial Average has dropped more than 1,000 points in a few days. Experts say much of the concern is about the bond market, rising interest rates and inflation.
Below is more information about the dropping stock market and how it is affecting the economy and interest rates, and vice versa.
Stocks had been going up since the 2016 election in part because of the strong economy. Unemployment is low and there are more jobs than people to fill them in some fields. Companies also are starting to pay workers higher salaries to keep them in their jobs and to bring in new hires. Businesses eventually will have to increases prices on what they sell to afford the higher payrolls.
The economy is doing well but price inflation has stayed quite low. The Fed fights inflation by increasing interest rates. The central bank has not been able to raise its key interest rates a lot over the last 10 years because of the fear of stalling the economic recovery.
But the Fed is planning at least two or three rate hikes in 2018. If inflation starts to rise more, the Fed could increase rates more and more steeply than it plans to. If this happens, we can expect interest rates on mortgages to rise faster.
As the Fed increases interest rates, the cost for people and institutions to borrow money rises. This means companies need to pay more for loans and this reduces corporate profits. It means you will have to pay more for loans, including mortgages.
The stock market has risen markedly until recently because of the growth in corporate profits. Companies have a healthy bottom line and investors have rewarded this by investing more and increasing stock prices. But when interest rates start to rise, stocks may fall. Investors are concerned that business profits will start to fall.
Bond Market Worries
Stocks have been going up because they have been one of the few investments with a solid return in the past several years. Treasury bond yields have been so low that dividends on stocks often pay more. But stocks are always a higher risk investment than bonds because the latter is backed by the US Treasury.
If bond yields begin to rise, investors will want to take some money from their stock portfolios and put it into bonds which are safer.
Last week, bond yields hit a four-year high. The recent federal tax bill is forcing the Treasury to borrow more money and more bonds are being issued. A glut in supply can make the bonds less valuable. Yields and prices go in the opposite direction and bond buyers want a better yield and lower price for their investment to be worth it.
Inflation is always bad for the bond market. If borrowing costs rise, bond investors want to see a better yield and higher return.
Stock Market Went Up Too Fast
Stocks have gone up in a straight line since the presidential election. Some experts say this is not healthy. Stock market analysts think the stock market has been due for up to a 10% correction. A cooling off period could be good for the markets, some say. This would make stocks cost less and more attractive to new investors. This is especially true if the companies that issue the stock are healthy and making good sales numbers and profits.
The market has been coming back to earth somewhat and in the long run, this could be a good thing for the economy.
If You Plan to Buy a Home This Year
While the stock market has gone down some in the last few weeks, the underlying economic indicators are still healthy. It is expected that the Fed will increase its key interest rate and this will cause mortgage rates to rise above where they stand today in the low 4s for a 30 year fixed mortgage. Because of this, it is unlikely that rates will go down much if at all in 2018. If you plan to buy a home in the next few months, it would be advised to lock your rate as long as you can and close the loan before rates rise.
If you plan to buy later in the year, rates could be higher. So you may need to buy less home, have higher income or put more money down to buy the same home that you could today.
It is unlikely that the stock market will crash and bring lower interest rates; the current down cycle is probably temporary and will level out as 2018 unfolds, many financial experts believe. The fact that the economy is otherwise quite healthy is a good indicator that mortgage rates will continue to go up somewhat this year.
References: Read CNN Money on the Market