By: Larry MacDonald

Many market analysts and strategists are saying the U.S. economic recovery is at risk because of the rise in government-bond yields and mortgage rates. “Nonsense,” says Northern Trust’s Director of Economic Research, Paul L. Kasriel.

Mortgage rates may be climbing but they are still near historic lows. Moreover, Kasriel notes, there is another factor besides mortgage rates that affects housing affordability: house prices. They have fallen to such an extent against income that measures of housing affordability are at historical highs (see chart below). In short, even with the uptick in mortgage rates, housing affordability is still very high.

True, mortgage refinancing activity has tumbled. But mortgage applications to buy a house are still edging up and they are more important in terms of stimulating the economy.

Refinancings (not involving the cashing out of equity) may lower monthly interest payments for the home owner and free up money for the purchases of goods and services but they also lower interest income received by lenders. So the net effect is “simply a redistribution of spendable income from ultimate lenders to ultimate borrowers.”

However, mortgage financing to buy a house is more than “a wash in terms of aggregate demand for goods and services.” In the case of the purchase of a newly created house, the construction industry is a major beneficiary. In the case of the purchase of an existing house, the renovation, furniture, and other housing-related industries often get a boost.

As for the notion that rising interest rates on U.S. government bonds are crowding out private-sector borrowing, Kasriel doesn’t buy it. As Kasriel’s chart below shows, yields on private sector debt are declining. That’s because risk appetite is recovering. The rise in government bond yields is part of the normalization in risk appetite — and is a good sign for the recovery.

Down the road, there may be some competition between the public and private sectors in debt markets but for the foreseeable future there is none. “Nonfederal domestic borrowing … has gone from an average $2.1 trillion annualized in the four quarters ended Q1:2008 down to only $291 billion in the four quarters ended Q1:2009,” writes Kasriel.