However, interest rates won’t go up unless we are in an inflationary environment. In an inflationary environment, salaries will increase too so that will put upward pressure again on home prices.
For starters, 10-year is at 3.6% today even though we’re not in a deflationary environment. (At least not in the strict sense of the word) Interest rates are so low because we have a bear market in stocks, resulting in flight to safety. Flight to safety temporarily overrides any deflationary/inflationary mechanisms that might be otherwise going on.
Bear market will end eventually and at that point 10-year yields will likely go back into 4-5% land, if not higher.
Secondly, interest rates may go up if spread between 10-year and mortgage increases. This will happen if GSEs start experiencing financial problems.
Now, about an inflationary environment. Inflation results in higher long-term interest rates, higher wages, and depreciated currency. The effect on long-term interest rates and exchange rates is immediate (investors’ expectations can change overnight). The effect on wages is drawn-out and delayed. In fact monetary expansion does NOT lead to wage inflation as long as there is substantial unemployment. Only when the unemployment is low, monetary expansion will start to translate into higher wages for everyone.
