Rate update: Reasons rate should be lower

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Sep 162019
 

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By G. Steven Bray

What a difference a couple weeks make. Last week, the press was reporting the lowest mortgage rates since 2016. This week? Well, we lost a little ground. Rates rose about half a point in two weeks.

So, if you approach decisions cautiously (like I do) and didn’t jump into a refinance, are you out of luck? I think not, but you may have to practice a bit of patience. Last week’s bounce higher may have been nothing more than a market reaction to the rapidity with which rates fell at the end of Aug.

Recall back to earlier posts when we discussed the reasons rates were falling: Europe appears headed for a recession, Brexit remains unresolved, and China’s economy is slowing dramatically due to the ongoing trade dispute. On top of that, talking heads have spent the summer trying to talk the US economy into a recession. Little has changed to mitigate those concerns.

Given that, I think it’s likely rates will ooze back down again. The question is when. Here’s what I’m watching:

  • The Federal Reserve meets this week, and pretty much everyone expects it to cut short term rates by a quarter point. That’s already priced into rates. What I’ll be watching is what the Fed puts in its post-meeting announcement and what Fed head Powell says at his press conference. If the Fed doesn’t acknowledge ongoing risks to the economy, rates will remain elevated longer.
  • Second, US manufacturing data has been soft, but consumer data has remained strong. If consumers stop spending money, the US economy will be headed for a soft patch, and that will move rates lower.
  • Finally, the trade war with China is hurting both countries, but it seems to be hurting China more. That may be softening China’s resistance to compromising on some of the thornier issues. A complete resolution seems unlikely anytime soon, but a thawing of positions might give markets confidence in the US economy and keep rates higher.

Rate update: The big reason mortgage rates aren’t lower

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Aug 142019
 

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By G. Steven Bray

Trade uncertainty last week set off a feeding frenzy in the bond market. Investors gobbled up Treasury bonds in a flight-to-safety buying spree that saw the 10-year rate drop by 40 basis points (0.4%) in just over a week. The 10-year rate is now the lowest it’s been since 2016.

Given that we always talk about mortgage rates tracking the 10-year Treasury, shouldn’t mortgage rates be looking superb right about now? Well, not exactly. While mortgage rates tend to move in the same direction as the 10-year T-bill, there’s one big reason that mortgage rates lag behind when it comes to rapid rate changes.

When an investor buys a 10-year Treasury bond with a 2% rate, the investor knows that bond will pay 2% interest for exactly 10 years. Period.

When an investor buys a 30-year mortgage security with a 3% rate, the investor knows it will pay 3% for 30 years if and only if the borrower doesn’t sell, refinance, die. Of these, refinancing is the greatest risk when rates are moving lower.

Let’s say an investor buys a mortgage security with a loan balance of $1 million paying 3%. The investor expects to receive payments equal to the loan balance PLUS the interest paid on the loan, so the investor pays $1.04 million for the security – a premium to account for interest.

Now, let’s say rates keep dropping, and the borrower refinances after 12 months. The borrower has paid roughly $30k in interest, but the investor paid a $40k premium. Not a winning investment strategy.

Investors still want to purchase mortgage securities, so what do they do? They reduce the premium they’ll pay. The way this shows up for borrowers is in the interest rate.

In the example above, it takes $40k of premium to make everyone whole in the mortgage transaction. If the investor only offers $30k, the lender needs to make up the extra $10k, and it does that by offering the investor (and, thus, the borrower) a slightly higher interest rate – thus inducing the investor to pay the required premium.

Now, the borrower will see a lower rate than before rates fell because the cost of money is lower, but the borrower’s rate won’t fall as quickly as that of more predictable bonds, such as Treasuries.

If Treasury rates settle into the current range for a while, the refinancing risk will abate, and mortgage rates eventually will catch up.

Rate update: Thank cheap Chinese imports for lower rates

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Aug 052019
 

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By G. Steven Bray

If you needed a recipe for a rate rally, just take a look at recent financial headlines. Friday, the President announced a tariff on an additional $300B worth of Chinese imports, and the investor herd started making flight-to-safety trades, buying up US bonds. When the demand for bonds is high, rates are low (because the bond issuers don’t have to offer as much interest to entice bond purchases).

Almost lost in the stampede was last Wed’s Fed rate cut and the good jobs report on Fri. Without the stampede, I’d hazard that we’d be stuck in the summer doldrums again, wondering when rates would move higher or lower. Fed head Powell hemmed and hawed when asked if the Fed would cut rates again this year, and the jobs report was strong enough to suggest a continuation of moderate economic growth. Neither provided a clear signal to investors.

But investors got their signal Fri and believe it was reinforced by weak global economic data today. On top of that, China devalued it currency overnight to levels not seen since the depths of the Great Recession.

That matters because it suggests a number of rate friendly effects. It suggests the trade war isn’t going to end soon. By devaluing its currency, China hopes to keep its good competitive despite the tariffs. Lower import prices lead to lower inflation, the mortal enemy of interest rates. And it increases the chances of a recession, and that increases the chances the Fed will have to lower short term rates even further.

As usually happens when Treasury rates fall so quickly, only a fraction of the gain has filtered through to mortgage rates. However, if Treasury rates remain in this new, lower range, mortgage rates eventually will catch up.

Rate update: Will the Fed surprise us?

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Jul 232019
 

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By G. Steven Bray

Interest rates have settled back into a narrow range while markets await the Federal Reserve meeting next week. The Fed has strongly telegraphed its intention to cut short term rates, and recent positive economic data has convinced markets it will only be a quarter point cut. So, with that decided, what possible motivation could rates have to move?

Well, I’ll give you a couple, but I think they’re outliers. The first is headlines from the Middle East. So far, the US and its allies seem content mostly to ignore Iran’s provocations, allowing the punishing economic sanctions to continue to work. Should Iran get more desperate and start a shooting war, interest rates will tumble quickly.

The second is the Chinese trade tiff. I’m calling it a tiff because despite the doomsday prognostications from the experts, the damage to the US economy seems to have been quite limited. The Chinese economy, on the other hand, seems to be suffering. Should the Chinese finally decide the pain is too great and strike a deal, it will relieve some of the uncertainty that’s been keeping rates low.

Absent those events, I think it’s a balancing act between weakening foreign economies and the still-strong US economy. And as long as we remain in balance, rates really don’t have any motivation to move.

Rate update: Choppy waters ahead

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Jul 162019
 

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By G. Steven Bray

Following the surprisingly strong jobs report at the beginning of the month, mortgage rates have started edging up again – but without conviction. Rates are being affected by several factors right now, and those factors seem fairly balanced.

On the one hand, we have deteriorating economic conditions in Europe and China worrying investors of a global economic slowdown, which would push rates down. The Federal Reserve has acknowledged this ‘fear factor,’ which made markets very happy a couple weeks ago and supported lower rates.

On the other hand, US economic conditions remain healthy, as evidenced by the strong Jun jobs report earlier this month and today’s very strong retail sales report. On top of that, the inflation report last week came in a tad higher than expected, and inflation is the big enemy of low interest rates.

I expect rates to remain choppy and noncommittal until the end of the month when the Fed meets again. Based on Fed head Powell’s Congressional testimony last week, markets fully expect the Fed to cut short term rates by 25 bp at that meeting, so that action probably won’t move the needle. However, if the Fed fails to cut rates or cuts more than expected, watch out. And we’ll talk about those possibilities in the upcoming weeks.

Rate update: Rates are heading lower

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Jun 012019
 

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By G. Steven Bray

Interest rates have had an impressive rally the last couple weeks as investor sentiment has become decidedly dour. The rally began in earnest when the Chinese blew up the trade deal, but it’s taken on renewed life as talking heads have started tossing around the “R” word again.

Unfortunately for economic growth, now they have something on which to hang their hats. While employment growth and consumer sentiment still appear strong, some economic activity indicators are pulling back.

This may be a manifestation of the trade war, which means it could reverse if negotiators are able to craft a deal soon. However, other economies, particularly those of China and Germany, are slowing even more quickly. We may already be past the point of no return in terms of the next recession overseas.

So, what does this mean for mortgage rates? If you like lower rates, it’s all positive. It’s quite likely we haven’t seen the lowest rates of the year yet.

That said, it may take a while before that happens. It’s long-term Treasury rates, which readily respond to economic conditions, that have fallen so much recently. Mortgage rates are lagging behind for reasons that aren’t likely to change soon.

Even so, investor sentiment is such that traders may ignore a positive economic report, such as next week’s jobs report, and keep rates in their current, lower range, and over time, mortgage rates will catch up.

Rate update: The trade war blues

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May 212019
 

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By G. Steven Bray

Mortgage rates have moved very little this month, and it still seems like their next move is tied to the trade war. The announcement of new tariffs on Chinese goods created a nice little rally that brought rates down close to their lows for the year. But lately, it seems like every negative headline has been met with a conciliatory one, which has kept rates stable.

There is other news out there, and absent the trade headlines, it might move rates. Probably the most significant is the action in the Middle East. A new fighting war would roil markets everywhere and lead to lower rates.

Europe also has current crises of note. Great Britain still has a Brexit problem – deciding how it’s going to leave the European Union. Italy, on the other hand, just thumbed its nose at European Union austerity rules, and pundits once again are talking about the survivability of the EU.

In the US, we’re watching for economic data that indicates something other than a steady as she goes economy. The next big reports aren’t due for a couple weeks, culminating in the May jobs report due on Jun 7th. Analysts aren’t predicting any surprises based on recent economic activity.

And that brings us back to the trade war. Barring something extraordinary happening elsewhere in the world, I think the fate of interest rates depends on the success or failure of trade talks. Resolution would remove the biggest uncertainty for the economy and almost certainly would lead to higher rates.

Rate update: Trade war is our headliner again

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May 072019
 

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By G. Steven Bray

Last week’s two big ticket items, the Federal Reserve meeting and the jobs report, lived up to their billing. The Fed didn’t change policy, nor did the post-meeting announcement really make any waves. It was Fed head Powell, at his post-meeting press conference, who got things moving. He acknowledged that foreign economies look a little stronger than earlier in the year and was equivocal when asked whether the next rate move would be a cut or a hike. (Investors have been hoping for a cut.) Interest rates quickly bounced higher.

Then, we got the jobs report on Fri. The headline numbers were great: a solid beat on jobs created and the lowest unemployment rate in 50 years. However, wage growth was tepid, reinforcing concerns about falling inflation (which tends to depress rates). On top of that, the services sector report missed expectations. Interest rates edged down again, and it looked like we’d be riding the range a while longer.

This week set up to be rather quiet until Friday’s inflation report – until the Chinese pulled away from trade negotiations. Markets have been hopeful for a trade deal, so the president’s threat to impose new tariffs created waves of uncertainty. Investors responded to that by buying bonds, which pushed rates down.

So, where do we go from here? Given that multiple recent economic reports have agreed about receding inflation, it’s unlikely Friday’s Consumer Price Index is going to have much effect on rates. If the index surprisingly doesn’t agree with the other reports, rates may tick up a bit.

However, I suspect rates will rise or fall based on the trade talks. A further breakdown is bound to make investors nervous about a full blown trade war, leading to lower rates.

Rate update: Stuck in the middle again

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Apr 122019
 

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By G. Steven Bray

After a quick move lower following last month’s Federal Reserve meeting, mortgage rates have moderated a bit. Concerns of a global recession prompted the move lower, and the Fed seemed to add fuel to that concern with the changes to its policy stance, announcing what is in a sense version 5 of quantitative easing, which has helped keep rates low for years.

Rates rebounded a bit when investors realized the US economy certainly isn’t circling the drain. We’ve had two strong jobs reports, and retail sales rebounded after the government shutdown. The data isn’t as strong as it was last year, but it certainly doesn’t seem to indicate an imminent recession.

Overseas is another story. At its meeting this week, the head of the European Central Bank all but predicted a recession in Europe, and European economic data continues to weaken. Britain still hasn’t figured out how it’s going to leave the European Union, which breeds uncertainty, a close friend of low interest rates. And China’s economy also is slowing, and analysts worry that a resolution to the trade dispute may not be enough to stop the slide.

So, that’s the bad news – the news that’s pressuring rates lower. But investors see a US economy that seems to be chugging along. Thus, rates are stuck in the middle – not sure which force is going to be stronger. And they’re liable to stay that way until new headlines tip the scales.

Among the predictable headlines I’m watching right now are the Chinese trade talks and inflation data. I still believe a good trade deal penned in the next couple months will put some upward pressure on rates. However, it has to happen before the Chinese economy slips too far. On the inflation front, recent reports show inflation sliding lower again, which makes the Fed nervous. Receding inflation should put downward pressure on rates.

Rate update: 4 events that could break the range

 Interest Rates, Residential Mortgage  Comments Off on Rate update: 4 events that could break the range
Mar 132019
 

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By G. Steven Bray

Still riding the range. It’s not a bad place to be when mortgage rates are the lowest they’ve been in a year. This range has held for an unusually long time, and we’ve been looking towards this month as the time when the range finally might break down. There’s no sign of that yet, but let’s review some events that could make it happen.

US economic data probably carries the greatest weight. Most of the data this year has shown continued economic strength – until the Feb jobs report. The report didn’t just miss expectations, it was anemic. Could it be an outlier due to the government shutdown or seasonal factors? Possibly. The Jan number was oddly high. Regardless, the weak jobs report combined with this week’s tame inflation reports have bond buyers in a frisky mood, and that’s good for interest rates. Any additional weak economic data likely will get the recession whisperers going again, and rates could break lower.

The other elephant in the room is the ongoing Chinese trade talks. I still think a trade deal is likely to pump up rates a bit as it not only will remove impediments to economic growth, it will remove the uncertainty that acts like a weight on rates.

Foreign economic uncertainty carries less weight, but its pervasiveness at the moment may be giving it an over-sized effect. Brexit talks continue to flounder, and a no-deal divorce between Britain and the EU is full of unknowns. The European Central Bank last week again lowered its growth estimates and discussed stimulus measures to shore up the European economy. Chinese growth has cooled significantly, and recent data shows its manufacturing sector in contraction.

Finally, we have the Federal Reserve meeting next week. The Fed had a large part in setting up the current range with its about-face on rate hikes following its Dec meeting. Markets currently see little chance of the Fed raising interest rates soon. Should the Fed’s post-meeting announcement suggest otherwise, rates could make a quick jump higher.