ARMs Race Leaves Yellen Able to Raise Before Carney

Federal Reserve Chair Janet Yellen still may beat Bank of England Governor Mark Carney to the punch bowl.

While investors bet the U.K. central bank will raise its benchmark interest rate as soon as the end of this year, with its U.S. counterpart following six months later, economists at London-based Fathom Consulting aren’t so sure.

They “would not be surprised” if monetary policy is tightened first in the U.S., satisfying former Fed Chairman William McChesney Martin’s edict that the job of the Fed is “to take away the punch bowl just as the party gets going.”

A Commerce Department report today showed the U.S. growing at a 4 percent annualized rate, faster than the 3 percent median forecast of economists surveyed by Bloomberg News. Unemployment is also falling and Fathom economists Laura Eaton and Phil Lachowycz reckon wages may soon pickup.

While the International Monetary Fund has called the U.K. the fastest-growing rich economy this year, Fathom says the U.S. household sector may be better placed than that of the U.K. to stomach higher interest rates. No one expects Yellen’s Fed to act on interest rates when policy makers meet today.

A key measure of how vulnerable households are to increased rates is their exposure to variable-rate home loans, known as adjustable rate mortgages or ARMs in the U.S.

In the U.S., the share of mortgage applications based on such loans has declined to fewer than 20 percent from about 50 percent before the financial crisis, according to Fathom’s July 28 report.

U.S. Refinancings

“Falling bond yields have allowed households to take advantage of cheap fixed-rate mortgages and encouraged homeowners to refinance,” Eaton and Lachowycz said. “The impact of a relatively modest tightening on debt-servicing costs in the U.S. is likely to be small.”

By contrast, about 70 percent of outstanding British mortgages are at a variable rate, meaning the BOE will try to keep increases to a minimum, they said.

“With the labor market tightening rapidly, and inflation surprising on the upside, there is a real chance that the Fed may be the first to move,” Fathom said. “The U.S. household sector is far better placed than the U.K. household sector to deal with higher interest rates.”

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