By Mark Sprague, Independence Title’s Director of Information Capital, with Kara McGregor, Senior Vice President
The question continues to be, “Why are mortgage rates going up after the Fed rate cuts earlier in the fall?” That’s why I love Wall Street’s responses to major news, or rather, what’s behind the news. You can listen to the talking heads and read the headlines, but the movement of the markets tells you right away where investors think the economy is headed, short-term and long-term.
As Dr. Elliot F. Eisenberg, Ph.D., sagely points out, “Portions of Trump’s 2017 tax cut have already sunset; others will expire in 2025. Extending the unexpired sections will cost $5 trillion through 2034 but will have no impact on GDP or inflation as they will simply extend existing policies. However, lowering corporate taxes, exempting tips, Social Security, and overtime from taxation, and making car loan interest and S.A.L.T deductible will boost GDP but raise the deficit by $4 trillion.”
In other words, this list of proposed tax changes will raise the deficit. And a higher deficit combined with proposed new tariffs and immigration policies focused on deportation will fuel inflation. (Both candidates proposed degrees of new tax cuts, spending, and tariffs on the campaign trail.)
We saw the stock market shoot up after the election, grabbing headlines, while bond prices sank. For someone invested only in stocks and equities, this is all fine … but investors in bond markets drive interest rates, which in turn impacts real estate markets, so let’s explore …
The Fed has lowered its rate, yet mortgage rates have ticked back up. That is because investors believe the proposed tariffs, reduction of tax revenue, deportation of swaths of the workforce, etc., will be inflationary, and they don’t want to be holding the bag on lower-rate mortgages if inflation spirals back up.
How do some proposed policies affect inflation? Take a cotton farm in Arkansas …
Today, for $2,500, 8 workers can process and deliver cotton to the processing gin. (This isn’t 1960 when the farmer needed 50 workers. He has a harvester for the picking.) They are likely undocumented migrants, probably from Latin American countries, where life is a lot harsher than working on a farm. They come, stay for 70 days, work 12 hours a day at $3 an hour plus food, and go home.
Tomorrow, if only documented residents are allowed to do this work, labor will cost the farmer a minimum of $10 an hour or $8,500 for eight workers to complete the job. So, the farmer who once paid $20,000 for labor for his cotton harvest now pays $68,000. That’s $48,000 that gets passed through the supply chain to the consumer. That’s inflation. The same holds for food crops, construction costs that impact housing prices, and more.
Now consider the John Deere tractor the cotton farmer needs to harvest and move the cotton and proposed tariffs …
John Deere can build a tractor for $5,800 in Mexico and sell it for $33,000 in the USA, leaving a slim profit margin after other company costs (transport, insurance, registration, staff, brick-and-mortar, advertising, etc.).
If John Deere has to pay the proposed 100% tariff on goods manufactured in Mexico (based on the tractor’s market value plus shipping and insurance costs), the price of the tractor doubles.
And if John Deere builds tractors in the US, it costs $22,000 to make the tractor—more than three times the cost to build in Mexico—which brings the retail cost upwards of $57,000, even if the company tamps down its profit margins to stay competitive.
Back to cotton: Between higher labor and machinery costs to produce cotton domestically and steep tariffs on imported cotton, prices go through the roof, and your clothing bill explodes, as does the cost of furnishings, towels, linens, uniforms, and anything else that uses cotton textiles. Potentially, the farmer goes out of business from reduced demand and the layoffs of his American workforce.
Now imagine tariffs on products that we simply don’t produce domestically. Those tariffs do not help American companies compete; they simply make electronics, home goods, machinery, fruits and vegetables, and apparel more expensive. This equals inflation, reduced consumer buying power, and shrinking GDP. And let’s not talk about where things go from there.
Tariffs are inflationary no matter how you look at it, as are policies that will reduce tax revenue, and eliminate cheap labor. Inflation — even the fear of inflation — drives higher mortgage rates, as we are experiencing currently.
Clear as mud? With the election and the campaign rhetoric of both candidates behind us, we can hope for a more nuanced and big-picture approach to economic and tax policy and a calming effect on investors.
