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 mortgage bonds in order to drive down interest rates and stimulate the economy. Since 2009, the Federal Reserve has purchased a staggering $1.7 trillion of mortgage bonds, and they’ve been the largest buyer of bonds in the market.
This has had the impact of keeping interest rates very low. In October 2017, the Fed began reducing their bond purchases, and they expect to gradually phase out their bond-buying program throughout 2018. This may cause mortgage rates to go up. We will be watching the news, economic reports, and speeches from Fed policy-makers very closely to see how this tapering program impacts the market in the months ahead.
Another major factor that may impact mortgage rates is the growing level of federal government debt. This will lead to an increased supply of Treasury bonds hitting the market. This large increase in bond supply will take place simultaneously with the large reduction in bond demand that is resulting from the unwinding of the Fed’s bond-buying program as described earlier. This could cause interest rates to go up in 2018.
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.
- News: political headlines out of Washington, as well as events in North Korea, Europe, Asia and the Middle East, could all impact mortgage pricing. When there’s bad news in the world, investors typically buy bonds because bonds are considered to be a safe investment. This causes mortgage rates to improve. When there’s good news in the world, investors typically sell bonds and buy riskier investments. This causes mortgage rates to get worse.
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.