DEBT TALKS DRIVE MORTGAGE RATES

With few economic reports released this week, news of progress in talks to provide aid to troubled European countries and to raise the US debt ceiling had the most influence on mortgage rates. As the perceived risk of default in Europe decreased, investors retreated from the relative safety of US bonds, which pushed mortgage rates a little higher. The proposed deficit reduction in the debt ceiling talks was favorable for mortgage rates, however. The net result was little change in mortgage rates for the week.

European Union (EU) officials released a significant new plan for providing aid to EU member countries with debt problems. Thursday's announcement of a new aid package for Greece and an overhaul of the region's rescue fund reduced investor concerns that the debt problems will spread. In particular, the European Financial Stability Facility (EFSF) will have the ability to make loans to European nations at lower interest rates than they could get on their own, easing the risk of default. After the news, investors reversed some of the recent flight to safety trade and returned to riskier assets.

Recent low yields for Treasuries and mortgage-backed securities (MBS) indicate that investors have little doubt that the debt ceiling will be raised before the limit is reached on August 2. For bond investors, the big question has been to what degree lawmakers will tackle the budget deficit. Simply lifting the debt ceiling without meaningfully addressing the deficit would disappoint investors and be bad for bonds. By contrast, a serious attempt to bring the deficit under control rather than pushing the issue further into the future would likely cause yields to fall for two reasons. A smaller government deficit would mean a reduced supply of Treasury securities, resulting in lower yields, and less government spending would slow economic growth, reducing inflationary pressures. As a result, the amount of deficit reduction in debt ceiling negotiations could influence mortgage rates.