Making accurate predictions is a tough business, especially when forecasting the economy – or the future! Looking back, there have been some very good financial forecasts, and some equally bad ones.

In the late 1990’s Robert Shiller famously called the dot-com bubble, warning of inflated technology stock prices in his book Irrational Exuberance. Of course, the bubble burst in 2000, leading to trillions of dollars in lost market value from the stock market crash that followed.  Another famous prediction came in 2006 when Nouriel Roubini (aka Dr. Doom) forecast the Global Financial Crisis (GFC), widely known as the Great Recession, warning of a housing bubble that would result in widespread mortgage defaults and a worldwide banking crisis. Cracks began showing up in 2006, the year Pathfinder started, and the GFC began in 2007 as the U.S. housing market collapsed, driven by the issuance of low-quality mortgage-backed securities. The economy did not bottom out from the impact of the GFC until late 2009, but the effects are still being felt today. Shiller was correct again (that guy is good!) when he warned of a housing market bubble in 2005. Not only did he call the dot-com bubble in 2000, but also the Great Recession in 2007.

There have also been some poor economic predictions. Many smart people did not see the Great Depression coming – renowned economist John Maynard Keynes famously said in 1928, just a year before its onset, that “we will not have any more crashes in our time”, and Irving Fisher, another prominent economist of the early 1900’s, stated just days prior to the stock market crash in October 1929 that “stock prices have reached what looks like a permanently high plateau”. Ben Bernanke, then chairperson of the Federal Reserve Bank, said in 2007 that the “subprime mortgage crisis is contained”; we all know how that played out.

Now you would think that calling the general direction of the movement in interest rates would not be as difficult as calling a market bubble, whether in the stock market, housing market or tulip market.  I started to think about interest rates, and consensus opinions over the past couple of years on their future direction. I am starting to believe that when most people believe interest rates are going up, they go down, and vice versa. It made me wonder about sources that track interest rates and how past predictions have fared.  It brought me to forward interest rate curves and the Hairy Chart.

The forward curve for interest rates is a projection that graphically represents expected future interest rates over time.  It is derived from various forms of market data, including forward or futures contracts. The forward curve provides investment market participants (in real estate, the participants are borrowers, investors and lenders) insights into projected price and interest rate movements, and they also help to determine the loan terms lenders are willing to offer and the pricing of associated financial instruments, such as interest rate caps and swaps.  As an example, a real estate borrower taking out a variable rate mortgage may use the forward curve to project out the interest rates over the term of the loan to estimate the interest expense they will need to pay. That borrower may also buy an interest rate cap to mitigate risk (Pathfinder does this), which caps the maximum interest rate a borrower pays over a period for the loan. The cost of the interest rate cap is determined by the forward rate curve, among other variables (including timing, expected volatility, etc.).