Stocks and bonds compete everyday for investors dollars in the open markets, stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky. Remember: When there is weak economic news (higher unemployment, less homes sold), this normally causes money to flow out of Stocks and into more stable Bonds, helping Bonds and home loan rates improve, while strong economic news (lower unemployment, more homes sold etc) normally has the opposite result, so investors will put their money into more risky stocks, thus causing mortgage rates to increase. It is an interesting dynamic that generally bad economic news is good for mortgage rates!  

Inflation is going to be a problem sometime in the near future because of all this money that is being printed to pay for Government spending. So how will this affect mortgage rates? The bottom line is that as inflation increases, home loan rates will rise too. That’s because lenders know that a rise in inflation actually diminishes the value of the money they receive over the life of a loan, as the money they receive for payment simply won’t go as far. So when they see changes in inflation or even anticipate a rise, they increase their interest rates to make up for the loss in future buying power that will happen as a result of inflation.  

The Relationship between Mortgage Bonds & 30 year Fixed Mortgage Rates 

 

Mortgage rates are traded everyday as Mortgage Bonds (MBS) just like stocks. They either go up or down in price on a daily basis. Here is a picture of a MBS trading chart below. When MBS (green) are trading downwards, mortgage rates (red) will go up and when MBS are trading higher, mortgage rates will go down. 

 

   

When MBS trade lower, lenders raise their rates and distribute “Reprices for the Worse” (see chart below) and republish these higher rates to the public. This daily trading of MBS directly correlates to the mortgage rates we see everyday from our lenders. It is not unusual for rates to change 2 or 3 times in one day!

 

When Mortgage Bonds Trade Lower Mortgage Rates Increase

 

 

 

Investors recently have not been convinced that the worst is behind us and instead chose to continue to allocate funds into risk-averse assets like government guaranteed U.S. Treasuries. This “flight to safety” has allowed mortgage bonds to move higher and rates to go lower. But as the economy has started to show signs of recovery recently, rates have started to increase from all time record lows, investors are now taking funds out of less risky assets like bonds and are putting these funds back into the stock market which has a better rate of return. Remember as the equity market increases, it is usually a sign that the economy is improving, thus interest rates will increase.

Where will rates go from here?  

  

This entry was posted on Tuesday, July 6th, 2010 at 5:19 pm and is filed under A Simple Guide to Understanding Why Rates Go Up Or Down. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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