Category: Economics & Interest Rates

How foreign investors influence domestic mortgage rates

Posted on by Evan in Economics & Interest Rates

I’ve covered the topic before on ‘rate update‘ but I thought I would write a small blurb this morning because the WSJ had an interesting article on the topic.

As you may be aware the US sells a lot of it’s debt to foreign investors around the world.  When I say “debt” I mean US Treasury debt (debt secured by the government), mortgage-backed bonds (which directly influence mortgage rates), and other forms such as corporate debt.

For many years the US has relied on foreign investors to purchase our debt because we have spent more money than we’ve earned and/ or saved.  Since there has traditionally been strong demand for US issued debt interest rates have managed to stay low.  But there is growing fear that foreign demand may begin to weaken because of the growing national debt & the emergence of other economies (and their currencies) in the global market.  Should these fears come to fruition we would undoubtedly see long-term interest rates rise.

And according to Deborah Lynn Blumberg’s article in this morning’s WSJ online edition it may be more and more difficult to track foreign demand.  In the article she explains that more and more foreign buyers are shifting the manner in which they place bids on US debt.  Therefore, it is more difficult for analysts to differentiate who is a foreign or domestic bidder.  This has the potential to create uncertainty in the debt markets which would not be good for mortgage rates.

Thus far, the ever-growing size of the US treasury debt auctions has not had a major influence on long-term interest rates (including mortgage rates) but at the pace the US government is issuing debt (aprox. $120 billion every 2 weeks) industry analysts will have to try and make sense of it all with less information.

WSJ survey forecasts higher rates

Posted on by Evan in Economics & Interest Rates

The WSJ published results from a survey they did on Thursday and Friday of last week which shows that all 18 of the primary dealers that underwrite US Treasury auctions believe yields will be higher next year.  Here is a chart with the results:

The average forecast for the 10-year treasury was 4.125% which is about .50%-.75% higher than it has yielded over the past couple weeks.

Although mortgage-backed bonds (MBS’s) and 10-year treasury notes don’t trade in perfect correlation they are highly correlated.  It’s kind of like the relationship between the stock price for 3M (MMM) and the Dow Jones Industrial Average.  On any given day they may not trade in the same manner but over longer periods of time the two are highly correlated.

Therefore, what we can infer from this is since 10-year treasury notes are expected to increase in yield by .50%-.75% mortgage rates are likely to follow suit.

Day in and day out we may see temporary periods where rates fall but the overall trend is likely to be rates moving higher.

How a “flight-to-quality” trade helps mortgage rates

Posted on by Evan in Economics & Interest Rates

A “flight-to-quality” trade is not the latest comedic duo out of New Zealand but it is an important concept when it comes to tracking mortgage rates.  I will do my best in this post to explain what it is and how it impacts long-term mortgage rates.

“Flight-to-quality” is sometimes also referred to as “flight-to-safety” which is probably a better reference point for understanding the concept.

A “flight-to-safety” trade occurs when investors collectively shift investment capital away from traditionally “riskier” assets such as stocks and reinvest that capital into traditionally “safer” asset classes such as cash, cash equivalents, and fixed-income securities.  Mortgage-backed Bonds (MBS’s) are generally considered a “safer” investment and therefore are included in the latter.

When a “flight-to-safety” trade occurs selling pressure is placed on the stock market which sends the value of stocks lower.  In contrast, demand for “safer” investments increases which drives the value of these assets higher, pushing yields lower.

The result then of a “flight-to-safety” trade is ultimately favorable to mortgage rates.

Let’s quickly take a look at a real life example to show how this might work.  This morning we awoke to news that two major credit ratings agencies (Moody’s & Fitch) had each downgraded the credit rating on Greece & Dubai.

Their announcements spread concern amongst the investment community that debt and other assets issued from these less stable economies were risky.  As a result, we witnessed a “flight-to-safety” trade which sent the stock market lower and US dollar higher.  This trade is evident in the chart below where the purple line represents the Dow Jones Industrial Average and the green line represents the US Dollar index.

Flight-to-safety trade on Dec. 8, 2009
Flight-to-safety trade on Dec. 8, 2009

Mortgage rates benefited from this dynamic falling .125% from the previous day.

So, in summary, during a flight-to-quality in the financial markets mortgage rates tend to fall as investors seek out a “safe” place to park their capital until anxiety in the market dissipates.  Beware of the fact that the market always recovers and when it does the flight-to-safety trade unwinds and usually pushes rates back to the levels they were before the trade.

What kangaroo’s and rates have in common

Posted on by Evan in Economics & Interest Rates

For most people today’s news that Australia has lifted it’s key short-term interest rate for a 3rd-straight month is of no importance.  After all, you probably don’t hold any Australian deposits or aggressively speculate in foreign currencies.

What to roo's and rates have in common?
What do roo's and rates have in common?

However, if you’re shopping for a home or considering a refinance this morning’s headline is more news worthy than you think because interest rates abroad can impact interest rates here in the US.  Here’s how….

Investors with money to lend are constantly looking to obtain the highest yield with the lowest risk.  In today’s global financial marketplace they have more options than ever before.  When interest rates change it also changes the relative competitiveness of investment opportunities and therefore causes a shift in demand a country’s fixed income investments.  When demand for a country’s fixed income investments increases it drives their interest rates lower and vice versa.

For example, let’s say that yesterday XYZ hedge fund had $1 million dollars that they wanted to place in short-term deposits.  As of yesterday they could deposit that money in a US-denominated overnight account and receive a small rate of return of 0-.25% based on our Federal Funds rate.  However, had they deposited that money in an Australian account they could have earned a 3.5% return. Because of perceived currency risk or other factors they decide to stick with the US deposits earning a more modest return.

This morning ABC hedge fund is in a similar situation with $1 million to park in a short-term deposit vehicle.  They are now comparing the opportunity of US-denominated deposits at 0-.25% or Australian deposits at 3.75% (an extra .25% higher than yesterday).  They decide to deposit their money in an Australian account because the additional .25% of return is enough to overcome other risk factors under consideration.  As a result, it drives demand for Australian-denominated investments higher and interest rates lower while in the US it pulls money out of the domestic investment marketplace pushing interest rates higher.

My guess is over the next few months other economies around the world who were less impacted by the global credit crisis and more dependent on commodities (i.e. oil & metals) to make their economy run will follow Australia’s lead in raising short-term rates.  Little by little this will put upward pressure on interest rates here at home.

Norway becomes first Euro country to raise rates

Posted on by Evan in Economics & Interest Rates

The WSJ reported today that Norway’s central bank has joined the central bank of Australia in raising their short-term interest rates.  Clearly these two countries have navigated their way through the credit crisis better than others.  So why should you care?

When foreign countries raise interest rates they create higher yielding investment opportunities for investors relative to the US.  As a result, the US fixed income market is forced to offer higher yields in order attract money.  Therefore, as foreign countries begin to recover from the global financial downturn they will likely begin to raise rates.  This, at least theoretically, will push interest rates higher in the US.

This is one more indicator that higher mortgage rates are in store moving forward.

Good & Bad news for mortgage rates in Fed’s announcement

Posted on by Evan in Economics & Interest Rates

The Fed announced today that they would keep open market operations in the mortgage-backed bond (MBS) market active into early 2010.  This is great news for mortgage rates.  There had been growing speculation that the Fed would discontinue the TALF program which has been credited with keeping mortgage rates near historic lows as the eocnomy gradually improved.  However, the Fed also mentioned that they would not increase their commitment to purchase MBSs from the current $1.25 trillion amount.  Therefore, we still expect mortgage rates to rise into 2010.

The Fed’s TALF program has created substantial demand for MBSs since the program was announced last November.  The additional demand has pushed MBS prices higher which pushes yields lower.

Here are a couple excerpts from the WSJ.com article:

*The Federal Reserve, in a move aimed at keeping interest rates low for home buyers through early next year, decided to extend and gradually phase out its purchase of mortgage-backed securities.

*Mainly because of heavy government intervention in the mortgage market, interest rates remain near their lowest levels in decades. Rates on 30-year fixed-rate conforming mortgages currently average 5.24%, down from a recent peak of 5.81% in June but up from the year’s low of 4.84% in late April, according to HSH Associates, in Pompton Plains, N.J.

*The Fed is about two-thirds of the way through its mortgage-purchase program, which was launched late last year to support mortgage lending, housing activity and broader credit markets. The central bank’s decision to complete the full $1.25 trillion in purchases of mortgage-backed securities — rather than “up to” that amount, as it said in August — ended speculation that it might stop short, as a handful of policymakers have suggested. The Fed still plans to buy up to $200 billion in debt issued by Fannie Mae and Freddie Mac.

*Mortgage rates were expected to rise throughout the fall and winter as the Fed wound down its program to buy the mortgage-related securities. Even if they inch up, now they’re less likely to increase as sharply, given the Fed’s longer time horizon that stretches to March.

Will “slack” offset inflationary pressure of money supply?

Posted on by Evan in Economics & Interest Rates

This article appeared in the WSJ over the weekend.  It examines the impact that “slack” in the economy is having on curbing the inflationary pressures of money supply.

A couple weeks ago I posted this piece in which I wrote about Irving Fisher’s equation of exchange.  When you solve for price level (a change in which is the definition of inflation) you arrive at P=MV/Q where M= money supply, V=velocity of money, and Q= GDP.

In effect the WSJ article is arguing that although M has increased over the past year with government stimulus efforts V has slowed drastically and is expected to remain low for some time.  In essence, V represents “slack” in the economy.

At some point the economy will begin to rebound and the Fed will need to figure out how to unwind the money supply or else we may see double digit inflation which would likely lead to double digit mortgage rates.

The debate on inflation heats up

Posted on by Evan in Economics & Interest Rates

Here is a preview of an article I am releasing in an upcoming newsletter to my past clients:

It was Irving Fisher who contributed the equation of exchange to the world of macroeconomics. This equation states that MV=PT, where M= money supply, V= velocity of money, P=price level, and T= quantity of goods and services transacted (real Gross Domestic Product [GDP]).

This relatively obscure equation is the cornerstone of a hotly debated topic in the world of finance these days—namely, whether or not the government’s efforts to stimulate the economy will ultimately lead to acute inflation or not.

Why should you care? Inflation has profound effects on managing one’s personal finances, especially when it comes to managing one’s mortgage. Inflation is the main driver in mortgage rates; when inflation increases, mortgage rates follow suit.

The last time acute inflation struck our economy was in the late 1970s–early 1980s. In 1980, the Consumer Price Index, which is the most widely used measurement of inflation, increased by 13.5% from 1979. At that time, fixed mortgage rates averaged 16.63%.

So why are analysts currently concerned about the future prospect of inflation? Let’s return to Fisher’s equation of exchange. By using simple algebra and solving for price level we get P=MV/T.

According to Fisher’s equation, inflation rears its ugly head when money supply (M) and/or velocity of money (V) increase faster than GDP. In other words, when there are more dollars in the economy chasing fewer goods, we can expect prices to rise.

Through various programs, the government has flooded our economy with money over the past 12 months with the objective of stabilizing the housing and financial markets. As a result, money supply has increased by 9.0%, according to money stock measures from the Federal Reserve.

There are currently more dollars chasing fewer goods. However, because banks and households have been sitting on their stimulus money instead of lending or spending, inflation has yet to appear, and mortgage rates have remained low.

One side of the inflation debate contends that when the economy cycles back around for the better (pushing V and T higher in the equation), the Fed will not be able to unwind the money supply fast enough to curb inflation.

Arthur B. Laffer is one such alarmist who wrote an opinion piece in the June 11, 2009 Wall Street Journal entitled “Get Ready for Inflation and Higher Interest Rates,” in which he stated, “We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.”

Others, such as Gus Sauter, managing director and chief investment officer for The Vanguard Group, are not concerned. In a recent letter to investors, he stated, “I don’t think inflation is a foregone conclusion at this point … If the Fed is nimble enough, they may be able to stave off inflation.”

The reality is that we are in uncharted territory. The Fed’s balance sheet has swelled in the past year, and U.S. budget deficits are widening at an alarming rate.

When the economy does recover, these factors suggest we can expect higher inflation and interest rates. Theoretically, the Fed does have the tools to unwind the money supply without major inflationary implications, but I wouldn’t bet my house on it.

If you know you’ll need to manage your mortgage at some point in the next few years, please call us today so we can evaluate your situation and proactively discuss your options with you.

Speak Now or Forever Hold Your Mortgage

Posted on by Evan in Economics & Interest Rates

This is an article I wrote last week and will appear in an upcoming newsletter to my past clients:

On November 25, 2008, the Federal Reserve surprised the financial markets by announcing that it would include agency-issued mortgage-backed bonds (MBSs) in what has since become a $1.25 trillion open market operation known as Term Asset-Backed Securities Loan Facility or TALF. The goal is to improve conditions in the housing and financial markets.

Mortgage rates are inversely related to the price of MBSs. As the price of MBSs rises, mortgage rates decrease and vice-versa. The Fed’s objective in its commitment to purchase $1.25 trillion of MBSs was to create substantial demand; raising MBS prices and essentially subsidizing mortgage rates.

The results of the Fed’s plan are substantial when you evaluate mortgage rates over the past three years. From August 2006 through Novermber 2008, average 30-year fixed mortgage rates ranged from 5.875% to 6.625%. Since the announcement and active participation in the open market for MBSs, 30-year fixed mortgage rates have averaged between 4.625% and 5.50%.

Millions of homeowners have managed to take advantage of the Fed’s subsidy by refinancing their existing mortgages. Furthermore, thousands of homebuyers have been able to buy real estate at depressed prices with historically low mortgage rates.

But all good things must come to an end. As of August 2009, the Fed had used $766 billion of the $1.25 trillion slated for the program and announced that it would wind down this special program by the end of the year March 2010.

Even before the Fed officially discontinues its open market operations for MBSs we expect mortgage rates to rise in anticipation of their departure from the open market. It’s difficult to know exactly how much this will affect mortgage rates, but many analysts are predicting a 1% increase to fixed mortgage rates by the end of the year.

I realize that many homeowners refinanced in the first six months of 2009. Many others would like to refinance but can’t because of lower property values and/or tighter underwriting guidelines. However, there are many homeowners who have yet to contact us regarding refinancing information.

If you’ve thought about it but haven’t gotten around to calling, I would highly encourage you to do so soon. It costs you nothing to contact our office and at least discuss your situation. It costs you nothing to have us evaluate your situation and get back to you with options for your review. It costs you nothing to evaluate the information we provide.

However, once rates increase, as they are expected to do, it could cost you hundreds and even thousands of dollars over the life of your loan to not take advantage of the current level of mortgage rates.

Markets expecting more interest rate volatilty

Posted on by Evan in Economics & Interest Rates, General Mortgage Info.

According to this article featured in the Economist magazine back at the beginning of July the markets are currently less certain about the future prospects of long-term interest rates (i.e. mortgage rates).

The chart to the left shows that the “implied volatility” in the interest rate market has increased rather significantly since the beginning of the year.

What does this mean for mortgage rates?

First, it means that predicting mortgage rates accurately will likely be difficult in the coming weeks.

Second, it means that we may see wild swings in mortgage rates.  Instead of gradual increases and decreases over time that we’re accustomed to we might see more severe adjustments in shorter periods of time.

As always, if you’re happy with the fact that your interest rate is at a historically low level and your payments are comfortable it is probably a good idea to go ahead and lock in your rate to protect yourself.