Economic Data and Its Effects on Mortgage Rates

Cliff Pape asked me to do a post on how “inflationary expectations” for those who may not be familiar with its effects on mortgage rates both near and long term. His main concern is how it pertains to borrowers buying a mortgage today and for those hoping to refinance in two or three years, something every mortgage professional should be able to convey to their clients.

First off, let’s make sure everyone is clear that mortgage rates are determined by the trading of mortgage backed securities, mortgage bonds if you will. Mortgage bonds generally react like regular bonds in that they are considered a “safe haven” in bad times, so negative news on the economy is good for bonds, and thus mortgage rates.

For those who do not understand fully how bond pricing and yield work, I will hit on that quickly as I want everyone to understand the basic process for determining where rates are headed. Rates are basically like the yield on bonds. Bond yields move inversely to their pricing, so when bond prices move higher, bond yield drops, and thus mortgage rates drop. Of course the opposite is true and that is the simplistic version of how to determine what is going on with rates.

Now, to address Cliff’s request, since bad economic news drives bond prices higher, good economic news must drive them lower. Of particular concern is inflation and the “inflationary pressures”, which drive bonds prices lower (higher rates). You can see many signs of inflation when you visit the grocery store and fill up your car, both of which have increased your expenses lately. Some other inflationary pressures are not seen, such as “wage-based inflation”.

In our current environment, with money being so cheap thanks to the Fed, not to mention their “adding liquidity” and devaluing the dollar, inflation grows as commodity (oil, food, etc.) prices climb and the dollar loses purchasing power. Mortgage bonds traders, which had been focused more on the mortgage crisis and recession fears, have now moved over to inflationary concerns, and bond pricing has suffered, sending rates higher.

Compounding the problem is the expectations of what is to come, both near term and long term. As we see more and more data showing a better than expected economy and we see growing inflationary data, those expectations do not favor bonds, and we can expect higher rates in the future.

While the Fed has also apparently changed its stance from providing liquidity to that of doing what it is supposed to, fight inflation, we can expect them to hold the Fed Funds Rate steady, even increase it (hopefully). Keep in mind that what the Fed does today generally takes upwards of six months before full realization of their move occurs due to the need to “trickle down”. Since the Fed has cut rates, even in their most recent meeting, those inflationary pressures are likely to remain for up to six months unless the Fed can “shock” the system.

While no one has a crystal ball to see two or three years down the road with any real certainty, if we compare these times with those of similar economic times in the past, we can possibly gauge what could happen if future events follow suit. One of the most recent times would be that of the late 70s, early 80s, though it is not a fully accurate comparison.

Do you remember what happened to rates back then? Do you remember rates in the high teens?

I doubt we will get as high as we did back then, but I would bet we will not see rates as low as they are in the coming years. Does that mean you should rush out and get a fixed rate mortgage? Absolutely not. Does it mean you shouldn’t get an adjustable rate mortgage (ARM) right now? Not Necessarily. It does mean you should take a moment and revisit your mortgage plan and see if refinancing now will likely be the best option. If you have an ARM, you should definitely be looking at your options and future plans.

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