Mortgage rates in the last week in May 2009 saw a dramatic and baffling increase. Mortgage rates rose from about 4.75% for a 30 year fixed mortgage to about 5.25% in a matter of days. We were getting lender rate adjustments via email sometimes three or four times a day. Needless to say, everyone wants to understand why this is happened. I even heard Rush Limbaugh attempt to explain it on the air yesterday.

I’ll explain why I think this is happening…it can’t be any worse than Rush’s attempt.

Mortgage Rates Vs. Bond Yields

I have discussed before the idea of “comparable investment options” in the market for institutional investor like hedge funds, mutual funds, and foreign central banks. To recap, mortgage backed securities (MBSs) “compete” with the 10 year Treasury bond for investor dollars. Investor must assess the risks and returns available to them and choose which they’d rather put their money in…the riskier MBSs with a slightly higher return or the safer Bond with a slightly lower return (yield).

Mortgage rates are largely determined by this investor choice that is made in the market every day. Are investor “scared” of stocks and run over to the “safe” bond market flooding that market with their investment dollars? If so, that action will drive the bond yields lower. The MBSs market will see some of those dollars too since some of those fleeing stocks will want a slightly higher return than bonds offer. Subsequently mortgage rates drop.

Viola…both bond yield and mortgage rates are lower. Relative to each other, 30-year fixed mortgage rates are approximately about 1.5% above the 10-year bond yield. This “correlation” between mortgage rates and bond yields leads many to erroneously believe that bond market “moves” the mortgage rate market. Not true. The operate independent of each other. But because investor behavior is pretty consistent it appears the the mortgage market “follows” the bond market.

Why is this an important distinction in understanding mortgage rate moves?

Because if you had a “big” investor who pumps a lot of money into the MBSs market, mortgage rates will drop. Assuming no equal push was made in the bond market, we now have a lower mortgage rates with no corresponding drop in bond yields. This disconnect demonstrates no inherent connection between bond yields and mortgage rates, only a apparent one.

(Note:This also works in the other direction. Should investors flee either market, bonds or MBSs, then yields and mortgage rates rise.)

Right now the “big” investor in the MBSs market is the Federal Reserve…our own central bank. They are buying barrels full of MBSs to keep mortgage rates low.

Back to what happen the last week of May….

On May 21st Standard and Poor’s, a credit rating agency, said they were considering downgrading the UK’s debt from AAA. This got folks talking that the US may face a credit downgrade as well. This then lead to a lot of talk about runaway inflation Fed tightening, and the Chinese abandoning our Treasury markets.

That wild speculation triggered an exodus of bond investors driving the bond yields higher…from about 3% to about 3.5%. This then triggered an exodus from MBSs as well so mortgage rates rose from about 4.755 to 5.25%.

Where was our “big” investor savior, the Fed, during all of this?

Out to lunch is where…they forgot to pump more money into the MBSs market to keep mortgage rates lower.

So why did mortgage rates rise the last week of May? Rumors and the Fed being asleep at the wheel…that’s why.

We are still waiting of the Fed to step back in with more billions. Are they going to? Did they run out of money…or nerve?

All good questions with no answers.

We must note that everything settled down a little toward the end of the week, but it’s pretty clear rates will continue to be volatile and the Fed cannot be counted on to keep mortgage rates lower indefinitely.

Good Luck!

Previous Post:«

Next Post:»