Why Rates Have Gone Up

Since Memorial Day, conforming mortgage rates have jumped by more than 1.125 percent, adding thousands of dollars to the annual cost of homeownership.

To the casual observer, the moves may seem random.  There's a reason this is happening, however. 

It starts with inflation.

As an economic force, inflation erodes the value of the U.S. Dollar.  Left unchecked, it drives up the Cost of Living as each dollar "buys less" at the supermarket, gas station, or anywhere else.

But with respect to mortgage rates, inflation's impact is more immediate.  Because inflation devalues the dollar over the long-term, it renders long-term mortgage bonds a less attractive investment for traders. 

If bond investors are repaid in U.S. Dollars, after all, it would make the investment worth less if the dollar is in an inflationary freefall. 

Therefore, in situations when inflation is likely to present, we find that traders often sell out of their mortgage bond positions which, in turn, drives down the bond prices.  Then, because bond yields move in the opposite direction of bond prices, rising rates are the inevitable result.

Lately, Wall Street is fearing inflation for a number of reasons:

1. Job losses are slowing, adding to consumer spending expectations
2. Gas prices have risen 41 days in a row
3. The federal government is increasing the money supply

These 3 factors -- plus a few others -- are all coming to a head around the same time and traders are getting defensive with their portfolios.  As a result, they're selling their mortgage bond positions and it's driving mortgage rates higher.

Rates may continue to trek toward 7 percent through July and August, or they may retreat toward 5 percent.  We can't know for sure.  What we can know, though, is that volatility in rates should continue until the economic picture gets more clear. That could be next week, or next year.

For now, be ready to lock at a moment's notice.  Mortgage rates are changing quickly.