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 Treasury bonds and mortgage bonds in order to drive down interest rates and stimulate the economy. Since 2009, the Federal Reserve has purchased a staggering $1.6 trillion of mortgage bonds, and it has been the largest buyer of bonds in the market.
This had the impact of keeping interest rates very low. In October 2017, the Fed began reducing its bond purchases, and by October 2018, the Fed's mortgage bond buying program had undergone a near-complete wind-down.
In March of this year, the Fed indicated that it would not be increasing short-term rates any further this year and that it may gradually resume its Treasury bond-buying program over the next several months. Shortly thereafter, mortgage rates fell, and the 10-yr Treasury yield broke below 2.5% for the first time since January 2018. While the Fed is resuming its Treasury-bond buying program, the Fed won’t be taking the same approach with mortgage bonds. In fact, the Fed has even indicated that it may decide to start selling off its portfolio of mortgage bonds at some point. That said, it’s unclear at this point whether mortgage rates will decline further as a result of the Fed’s purchase of Treasury bonds.
Here are Three 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.
- Trade War News: tarriffs and trade wars have the short-term impact of causing mortgage rates to improve while investors shift their funds out of the stock market and into the bond market. However, market conditions could change at any time because tariffs and trade wars generally cause interest rates to go up in the long-run because of inflation.
Conclusion: we anticipate continued volatility in mortgage rates over the next several months as bond investors and the Fed decipher the 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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