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. This is called "quantitative easing" or "QE", and we've had several rounds of QE so far.
Currently, the Fed owns a whopping $1.75 TRILLION in mortgage bonds!
In fact, the Fed has been the biggest buyer of mortgage bonds in recent years, and is currently absorbing over half the supply of new mortgage bonds being issued in the market. If the Fed stops buying mortgage bonds, mortgage rates could increase.
The Fed has indicated that they will stop or slow down their purchase of mortgage bonds once they "normalize" the short term rate known as the Fed Funds rate. Recent Fed statements seem to indicate that this may happen sometime later this year.
In the meantime, the market will be watching very closely to see if the Fed changes their timeline on this. The Fed has already changed their timeline a few times, and they may do so again as new economic information comes to light.
Another major factor that will continue to impact mortgage rates is the market's reaction to a Trump presidency. Since the election results in November, 2016, mortgage bond prices have fallen off a cliff, causing mortgage rates to increase by 0.5% - 0.75% in less than 90 days.
Here are Three Economic 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.
- Supply and Demand in the Bond Market: if government borrowing increases from current levels, it could cause the supply of bonds in the market to increase. If the Fed stops or slows down its purchase of bonds, it cause demand for bonds to decrease. In either of these cases, bond prices would likely go down and interest rates would go up.
It will be interesting to watch how the market reacts to these economic trends in the coming months.
Conclusion: look for continued volatility in mortgage rates over the next several months as bond investors and the Fed decipher the economic trends that we've outlined above. Please contact me for more info on which economic reports may impact mortgage rates this week.
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