Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market.
WHY MORTGAGE BONDS?
When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other “securitizers”. These “securitizers” get their money by issuing bonds to bond market investors. These bonds are called “mortgage bonds” or “mortgage-backed securities”. Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market.
THE ROLE OF THE FEDERAL RESERVE
As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying Treasury bonds and mortgage bonds in order to drive down interest rates and stimulate the economy. In fact, prior to this year, the Fed had previously been absorbing about half the supply of new mortgage bonds that were coming into the market. This had the impact of holding interest rates down to artificially low levels. Last year, in 2018, while the Fed scaled back its bond-buying program, mortgage rates climbed by approx. 1% across the board.
In March of this year, the Fed indicated that it would not be increasing rates any further this year and that it may gradually resume its Treasury bond-buying program over the next several months. Shortly thereafter, mortgage rates fell, and the 10-yr Treasury yield plummeted. It’s unclear at this point whether interest rates will decline further as a result of the Fed’s purchase of Treasury bonds.
THE ROLE OF TARIFFS AND TRADE WARS
Recent economic reports illustrate that the US-China trade war is taking its toll by creating a slowdown in most economies across the world. The turmoil in the financial markets has caused home loan rates to drop to their lowest level in over two years. Whenever investors get afraid, they sell stocks and buy bonds instead, causing home loan rates to improve. If this trend continues, rates could remain low for a bit. However, don’t get too comfortable with low rates because things could change at any moment. The last time rates were this low, they jumped higher by nearly 1% in a matter of weeks.
HERE ARE THREE TRENDS TO WATCH IN THE COMING MONTHS:
- Inflation: bond investors and the Fed watch the inflation reports (CPI and PCE) to determine whether they should buy, sell or hold mortgage bonds.
- Jobs: bond investors and the Fed watch the jobs report and unemployment numbers very closely to determine if the economy is improving and whether they should buy, sell or hold mortgage bonds.
- Trade War News: tarriffs and trade wars have the short-term impact of causing mortgage rates to improve while investors shift their funds out of the stock market and into the bond market. However, market conditions could change at any time because tariffs and trade wars generally cause interest rates to go up in the long-run because of inflation.
It will be interesting to watch how the market reacts to all these trends in the coming months.
Conclusion: we anticipate continued volatility in mortgage rates over the next several months as bond investors and the Fed decipher the trends that we’ve outlined above. Please contact me for more info on which economic reports may impact mortgage rates this week.
Source: CMPS Institute
Carrero Mortgage Advisors, LLC
3600 Red Road Suite 310,
Miramar, Florida 33025
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