Category: Economics & Interest Rates

Dan Green explains why mortgage rates rise after Fed cut

Posted on by Evan in Economics & Interest Rates

Dan Green of The Mortgage Reports Blog posted this article today in which he explains the economic theory as to why mortgage rates often rise following a Fed rate cut.

Here are a few outtakes:

*The Federal Open Market Committee adjourns from its two-day meeting this afternoon.  The voting members are widely expected to lower the Fed Funds Rate by a half-percent to 0.500 percent, the lowest Fed Funds Rate in recorded history. Mortgage rates should rise in response.

*The Fed Funds Rate is an interest rate usually reserved for loans between banks, made at the close of the business one day and repaid at the start of business the next day.  This is why the Fed Funds Rate is often called an “overnight rate”  — the money is literally borrowed overnight.  By contrast, mortgage money is typically lent for 30 years — 10,957 overnight rates strung together.  It’s a completely different risk class for banks.

*That said, the Fed Funds Rate does have an indirect impact on mortgage rates because cuts to the Fed Funds Rate are meant to spur business and consumer spending, propelling the economy forward.  Mortgage rates come into play because there’s always the danger that the economy gets propelled too far forward and headlong into inflation.  We call this the Fool in the Shower Theory.  It says that the Fed is like a guy starting up the shower and turning the knob all the way to “H”.  Once the water heats up, as we’ve all experienced, it heats up quickly and the guy gets burned.  So, if Wall Street thinks the Fed is over-heating the economy long-term with its rate cuts today, expect mortgage rates should increase over the next 3 days.  This is what’s happened after each of the last 10 rate cuts.

Thanks Dan.

Fed rate cut and mortgage rates

Posted on by Evan in Economics & Interest Rates

The Fed is scheduled to announce their latest decision regarding short-term interest rates tomorrow.  It is widely expected that they will cut the Federal Funds Rate again by .50%.

I thought it appropriate to re-post the article I wrote back in February entitled, “Why Fed Cuts Do Not Lower Mortgage Rates“.

Conventional wisdom suggests that when the Fed cuts rates that mortgage rates would fall.  However, it’s important to understand that mortgage rates ARE NOT set by policy but instead determined by the direction in which mortgage-backed bonds trade in a free market.

Since the marketplace is already expecting that the Fed will cut rates the economic effects are already priced into the mortgage rates you see today.

Furthermore, it’s important to understand that there are economic implications from a Fed rate cut that can actually lead to higher mortgage rates.

For example, in today’s WSJ.com front page Yuka Hayashi explains why another Fed rate cut could cause Japanese investors (i.e. mutual funds and insurance companies) to flea US denominated securities for fear of a weaker dollar.  Aside from China, Japan is the US’s largest foreign investor of fixed income securities.

Although the article doesn’t specifically mention how large a stake Japanese investors hold of mortgage-backed bonds it can be assumed that if this exodus occurs it would add considerable selling pressure into the market which would actually put upward pressure on mortgage rates.

Therefore, we will likely continue to recomend to our clients to lock into these low rates.

Expert says “lock”!

Posted on by Evan in Economics & Interest Rates

With rates at multi-year lows many homeowners are reviewing their mortgages to see if it would make sense to refinance.  With rates so low often times it does.  However, many are not locking in their rates.  Why?  Because they believe mortgage rates will move even lower.

However, I just received an email from the CEO of a hedging company (helps mortgage companies manage their hedging efforts on interest rates).  Here is an excerpt:

Low rates — specifically the specter of 4.50% mortgage rates — roiled the mortgage market.  A news story broke that the Treasury might take mortgage rates to 4.50% (down from 5.69% currently), and home builders’ stocks surged.  Details of the program remain murky, but above-6.00% rate locks have begun to disappear from pipelines.  Low rates have touched off a modest refinance boom.

It is a good time to lock in your mortgage rate.  Without direct government intervention, mortgage rates to the consumer may not get all that much lower.  The spread between mortgage and Treasury yields is likely to drift higher, and even if Treasury yields drop further, the capacity of the mortgage industry is so low that mortgage originators are more likely to widen margins than lower rates.  At 2.86%, the spread between mortgage and Treasury yields is well off of its highs.  However, there is limited demand for mortgage securities.  Regardless of purchases by the Treasury, it appears that the market has found 3.00% over Treasury yields as the balance between supply and demand for mortgage securities.  Even an explicit guarantee of Fannie and Freddie debt probably won’t help; Fannie, Freddie, and Ginnie securities all yield the same today, and the Treasury only offers an implicit guarantee of agency debt.

He thinks it’s a good time to lock!

Mark-to-Market will likely remain

Posted on by Evan in Economics & Interest Rates

As a follow up to my December 2nd ‘rate update’ the Wall Street Journal is reporting that the SEC will likely NOT remove mark-to-market accounting rules which many have blamed as exacerbating the financial meltdown on Wall Street.

In case you’re not familiar with these standards the article explains:

Mark-to-market accounting requires companies to value financial assets at their fair value — the price they can fetch in the market. That has led companies to take big write-downs on thinly traded securities, even if the underlying assets aren’t severely troubled. The write-downs have put pressure on prices of financial firms’ stocks and forced many of them to sell assets or raise money to stay well above the capital requirements that have been set by regulators.

I had referenced the removal of these standards as being a potential catalyst for a stock market rally which would have put upward pressure on mortgage rates.  However, it appears for now this will not take place.

Deflation post #6

Posted on by Evan in Economics & Interest Rates

Dan Green of themortgagereports.com featured this helpful graphic on his blog today:

Deflation Post #5

Posted on by Evan in Economics & Interest Rates

John Schoen wrote this article on msnbc.com today about inflation.  He references the negative macro-economic implications of such an occurrence.  As I continue to say, hopefully the financial markets buy into the expectation of deflation but that it never actually takes hold.

This would create low mortgage rates for a window of time and create great opportunity for mortgage holders to refinance into historically low interest rates.

Rate Update November 20, 2008

Posted on by Evan in Economics & Interest Rates, Rate Update

Mortgage rates are modestly better this morning this morning.

In yesterday’s rate update/ you tube video we focused on the concept of “deflation”.

Coincidentally, the Federal Reserve released a report yesterday in which they acknowledged the future risks of deflation in our economy.  On that news the stock market slid to a new multi-year low as investors sold stocks and bought US treasury bonds.  While US treasury yields sank yesterday mortgage-backed bonds failed to benefit.  Watch today’s you tube video to learn more about the interest rate environment.

We believe that mortgage rates have a good chance of dipping lower over the course of the next few weeks/ months in response to deflationary expectations.  If you’d like to review your mortgage situation with us and establish a “trigger point” for refinancing please feel free to contact us.

Current outlook: neutral in the near-term/ floating in the long-term

Deflation post #4

Posted on by Evan in Economics & Interest Rates

This morning cnnmoney.com included a section in this article about deflation.  The article does a good job of explaining why a deflationary environment can be harmful to the health of the economy….especially in the retail sector.

Now, economists are worried about deflation – the opposite of inflation. Falling prices may be a welcome sign for consumers in grocery store aisles and filling up at the pump, but deflation is generally a bad sign for the economy.

…If prices fall below the cost it takes to produce products, businesses will likely have to cut production and slash payrolls. Rising unemployment would cut demand even further, sending the economy into a vicious circle.

The silver lining is that in a deflationary environment we would expect mortgage rates to move very low.  Here are links to 3 other deflation posts-

#1, #2, & #3

Deflation post #3

Posted on by Evan in Economics & Interest Rates

This weekend The Economist magazine published this article about developed economies and the likelihood that they will experience deflation in the next few months.

The article explains how deflationary pressures would be initiated because of falling commodity prices (known as “commodity-led deflation”).  The article goes on to explain how deflation can lead to further deflationary pressure.  How?

As deflation takes hold in the economy consumers who carry large debt burdens are faced with relatively more expensive obligations.  As this happens they are less likely to buy goods and services dampening demand and putting further pressure on prices to move lower.

I originally discussed deflation and the impact it should have in lowering mortgage rates in this post back on November 2nd.  We would expect mortgage rates to decrease as deflation becomes reality.

Deflation string-article #2

Posted on by Evan in Economics & Interest Rates

This past Sunday I blogged about Nouriel Roubini’s prediction that the US economy would face deflation in the next 6 months.

Today, cnnmomney.com has also published this article in which they report that deflation is becoming more and more of a concern for central bankers.

In terms of economic health deflation is a bad sign.  In terms of mortgage rates the expectation of deflation could help mortgage rates get very low.  That’s why I am hoping that expectations for deflation grow so rates can move lower but that we never actually reach that point.