Why Predicting Interest Rates is a Fool's Errand

GeneralBuyers

Aug 16

Written By Brent Edwards

Navigating the Unpredictable with Interest Rate Fluctuations

Interest rates might be 5.85% by the end of the year.

…Or maybe they will be 3.85%.

…. Or maybe will be 8.85%.

I don’t know. But what I DO know for sure is that mortgage interest rates will definitely be above zero. 👏👏👏 You’re welcome.

In all seriousness, no one really knows what interest rates are going to do or when. Anybody who says they know is lying to you.

Mark Fleming, a well-respected economist at First American, said, “You know, the fallacy of economic forecasting is: don’t ever try and forecast interest rates, and/or, more specifically, with your real estate economies mortgage rates, because you will always invariably be wrong.”

Many people want to point to different data points to support their predictions on where rates are headed. For example, someone might look at the ten-year treasury note and realize the spread between the thirty-year mortgage and the tenure note is usually 1.75%. However, in today’s market, the spread is closer to 3 percentage points. They will then point to the higher-than-normal spread as an indicator that rates are going to be lower in the future.

That analysis is not totally off-base. There are plenty of historic data points that would indicate why such an analysis would point to lower rates, but the trouble is that we don’t know if or when that’s actually going to happen.

The reality is there are so many different factors that affect interest rates so it is very difficult, if not downright impossible, to predict what interest rates are going to be and when. That’s why our friend Mark Fleming talks about forecasters being “invariably wrong“.

Predicting interest rates is like betting a parlay in sports. A parlay in sports betting is when the better makes multiple wagers and ties them into the same bet. If any bets in the parlay lose, then the entire parlay loses. However, if all wagers win, then the bet wins!

You might be thinking, what the hell does that have to do with interest rates? Well, when people are out there predicting interest rates, what they are in essence doing is placing a bet (predicting) that multiple wagers (or guesses) across all different areas of a global economic marketplace are all going to come in exactly as they think.

For example, one might see the United States inflation coming down, Fed Reserve members talking about rates coming down, and lots of talk of an upcoming U.S. recession. If I am trying to predict interest rates and see these three things happening, then I might venture a guess that interest rates are going to come down as they tend to do with low inflation, recession, and when the Federal Reserve is talking about low rates.

But then, boom! The European Central Bank (ECB) or Bank of England (BoE) raises their benchmark interest rates unexpectedly and that reverberates causing rates to go up in the U.S. In order to attract capital, we have to have yields (aka, interest rates) that are competitive with other first-world markets.

Or in a few other scenarios… maybe all data points to interest rates coming down in the United States only to see OPEC constrict the supply of oil to the marketplace. Or maybe Russia invades Ukraine, subsequently driving up oil prices, which then has inflationary pressure (causing the prices of our “stuff” to go up), which then causes bond traders in the United States to price their mortgage bonds in such a fashion that drives mortgage interest rates up.

You get the point.

It’s like the butterfly effect: a butterfly flaps its wings in Hawaii, and it causes an earthquake in India (or something like that). Except here, it’s more like a group of bankers in England surprise the markets in the United Kingdom, and it affects the markets here in the United States.

This is only a small snippet of why interest rates are so hard to predict. There are so many data points that affect interest rates that trying to predict everything from:

domestic inflation to
domestic unemployment to
European central banking economics to
oil production in the Middle East to
Russian military movements and beyond…

… and then trying to distill the impact of all of that into a mathematical equation that spits out a predicted interest rate is truly an impossible task for anyone.

So the next time you see someone in your email inbox or your Instagram feed telling you where rates are going, take it with a gigantic grain of salt because unless they are Nostradamus (an ancient French astrologer), then they’re probably going to be “invariably wrong”.

Brent Edwards (aka Brent the Broker) is a residential real estate agent and Realtor in San Diego, CA who helps clients buy and sell homes in San Diego, California and all surrounding areas. Brent is a highly-recommended Realtor in San Diego by family, friends and past clients. Call Brent today at 619-550-8070 if you have any questions about real estate in San Diego or you'd like to buy or sell a home.