Causes and Implications of Recent Interest Rate VolatilityLong-term interest rates took a roller coaster ride during the summer of 2003. The ten-year constant maturity treasury yield plummeted to a 45-year low on June 13, only to reverse course sharply over the next 45 days. This level of volatility is unusual by historical standards. Typically, such a sharp rise in interest rates is accompanied by strengthening economic data and accelerating inflation. While the emerging economic data were modestly positive over the summer, inflation continued to decelerate from already-low levels.
The short time frame for such a wide interest rate swing was also unusual, given the absence of major events or economic shocks during this period. Clearly, underlying fundamentals cannot explain fully such an abrupt movement in interest rates. So what caused this volatility? The blame probably can be laid at the feet of a "perfect storm" of related factors. The combination of mortgage-related hedging activity, deflation worries, and a rising federal budget deficit, among other factors, likely played a role. This article explores several possible catalysts of the recent increase in interest rate volatility and evaluates the likelihood that a more volatile interest rate environment may persist in the foreseeable future.
By Maureen Raymond, Senior Financial Economist
AtlantaThe housing sector is a key earnings driver for many of the Region's commercial banks, and recent increases in residential mortgage rates could challenge revenue streams.
ChicagoThe Chicago metro area economy and banking market are large and diverse. Its economy has underperformed that of the nation in recent years, and competition for the retail banking business is strong and intensifying.
DallasStrong demand and tight supplies are keeping natural gas prices high, benefiting gas producers in the Region but hindering farmers and manufacturers who rely heavily on consumption of natural gas.
Kansas CityDrought in the Region's western states significantly reduced 2002 net farm income. Farm banks based in areas of persistent drought are now reporting rising delinquencies and increased levels of carryover debt.
New YorkA steeper yield curve historically has been positive for bank margins, but the recent rise in interest rates may challenge banks in the Region that hold high concentrations of long-term assets.
San FranciscoRecord levels of mortgage prepayments have reduced mortgage-servicing asset values. Interest rate increases may boost servicing values but could heighten levels of extension and credit risk.