By Marla Barch, a real estate investor, mortgage planner, and contributing writer with Invest With Passion.
At cocktail parties, one often hears discussions of the stock market trends, with guests professing expertise on the reasons for market movement and predicting the future direction. They talk about websites like BullionVault.com and other places where they go for advice and tips on the market. While many believe they’ve deciphered the stock market, the majority will still admit that the movement of mortgage interest rates remains a mystery to them. This is the article they need.
To crack the mystery of the interest rates, we must first understand the source of mortgage funds.
What drives Mortgage Interest Rates?
The money in any real estate deal often travels a winding road, with many stops before arriving at the closing table. The mortgage broker or banker is not the final source of funds. Instead, he/she serves as one of potentially many intermediaries in the process of the mortgage being originated, funded, bundled and sold to investors on the open market. While there are several money trees that feed mortgages, the majority of funds lent to purchase homes ultimately comes from fund managers and traders purchasing mortgage-backed securities (bonds).
Every morning, lenders determine the interest rates on their fixed rate mortgages by analyzing the price of the mortgage-backed securities, such as Fannie Mae bonds, since this is likely where the loans will be sold. The bonds have an inverse relationship to interest rates. If the bonds are lower/worse, interest rates will be higher/worse and vice versa. If the bonds move tremendously during the day (more than 30 basis points), lenders will often re-price midday.
So we’ve established that mortgage-backed securities determine the mortgage interest rates. But what moves the mortgage-backed securities?
What drives Mortgage Backed Securities?
In an open market economy like ours, bond prices move up and down based on traders, fund managers, and others buying and selling that particular security. In order to limit their own risk, traders diversify their investments by dividing the majority of their limited capital between stocks and bonds. Various indicators such as economic data, stock movement, monetary policy, international politics, and technical data cause them periodically to shift more funds either to stocks or to bonds; thereby, creating a seesaw relationship between the two.
Several times per week, economic data is reported by the government and academic institutions, favoring positive returns in either stocks or bonds. If an economic report will likely be interpreted as good for the economy, the stock market will benefit and smart investors will shift their attention that way. On the other hand, if the interpretation suggests the opposite, money will be driven into the safety net of bonds – causing mortgage interest rates to improve. For instance, reports indicating that unemployment is higher than expected or desired will be interpreted as bad news for the economy. This will result in a downturn of stocks and a favorable return for bonds – and thus better mortgage interest rates.
Because they are directly affected by stocks, bonds also respond to corporate profit reports, losses, mergers, bankruptcies and more. For instance, March 17, 2008 saw an improvement of the 5.5 Fannie Mae bond by 116 bps (basis points), significantly improving mortgage interest rates. This was triggered by the news of Bear Sterns’ plan to sell stock to J.P. Morgan at $2/share, an enormous decrease from $90/share a few weeks earlier. As stock prices fell, investors shifted capital to bonds. Bonds have also improved after each report of large bank write-offs. Conversely, bonds performed poorly in response to banks being infused with new money by both the government and the private sector.
Based on the inverse relationship of stocks and bonds, let’s consider the impact of the Federal Open Market Committee (FOMC) and others in a position to influence monetary policy. Any actions designed to stimulate the economy will result in mortgage interest rates suffering. Despite the media’s constant assertion that Fed rate cuts will improve mortgage interest rates, the opposite can be evidenced by studying the historical responses of the mortgage-backed securities to Fed rate cuts and hikes. The day following the January 23, 2008 surprise .75 Fed rate cut saw a 94 bps worsening in the 5.5 Fannie Mae bonds and another 50 bps decrease the next day, for a total loss of 144 bps.
In today’s globalized economy, news from abroad sometimes impacts the U.S. market as strongly as domestic events do. Beginning on December 28, 2007, just prior to that surprise cut, bonds had increased about 200 bps over 4 weeks in response to the assassination of the Pakinstan opposition leader, Benazir Bhutto. Fear of political instability drove traders to the safety of bonds. On the contrary, the U.S. welcomed the news of Fidel Castro stepping down as the president of Cuba in February 2008, hoping that trade would open between the U.S. and Cuba. This news acted as a stimulus to our economy, hurting mortgage interest rates.
One final indicator of mortgage interest rates that needs explaining is technical data. Many methods have been devised in an effort to predict the direction of stocks and bonds. For instance, Japanese “candlestick” charts are often used to assess trends, determining floors of support and ceilings of resistance. This method makes use of moving averages, peaks, and troughs to anticipate change. Another common chart is the stochastic oscillator, which was designed to reveal when a stock or a bond is “oversold” or “overbought,” denoting a likely shift in the opposite direction, particularly when there’s a “negative stochastic crossover.” Learning to read these charts will be useful to investors beginning to follow the mortgage-backed securities. By observing changes on these charts, one can begin to draw connections to the causes.
As if suspended in a spider’s web, mortgage interest rates are tangled in an intricate network of economic reports, the stock market, national financial policy, international politics and the technical charts. But if you remember the rule of thumb that news that’s bad for the economy is good for mortgage rates and vice versa, you may be able to glimpse the mortgage interest rate trends. You’ll feel like a genius at that next cocktail party.
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Marla Barch is an investor and a mortgage planner with Pacor Mortgage. She specializes in helping investors reach their financial goals through effective management of their equity and cash flow, using advanced strategies to propel their wealth building. She can be reached at mbarch@pacormortgage.com.
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