If you have been tracking interest rates in the mortgage market, your head is likely spinning. Mortgage rates hit a record low of 3% less than a week later rates have risen again. What is causing the drastic swings? Is now the time to lock in or refinance? What did the fed just do?
What did the Federal reserve just announce in regards to rates?
The Federal Reserve announced a major policy shift Thursday, saying that it is willing to allow inflation to run hotter than normal in order to support the labor market and broader economy.
In a move that Chairman Jerome Powell called a “robust updating” of Fed policy, the central bank formally agreed to a policy of “average inflation targeting.” That means it will allow inflation to run “moderately” above the Fed’s 2% goal “for some time” following periods when it has run below that objective.
As a practical matter, the move means the Fed will be less inclined to hike interest rates when the unemployment rate falls, so long as inflation does not creep up as well. Central bank officials traditionally have believed that low unemployment leads to dangerously higher levels of inflation, and they’ve moved preemptively to head it off.
In essence the federal reserve is formally stating that they will keep interest rates low for an extended period of time even if there is an uptick in inflation. This should in turn keep longer term rates like mortgages and car loans at historic lows for quite some time.
How are mortgage rates, auto rates, and other long term rates “set”?
First, it is important to emphasize that the federal reserve does not control interest rates. They merely influence short term rates based on the federal funds rates. Long term interest rates (10-year treasuries) are market driven.
There are two drivers of long-term rates: Inflation expectations and Market Forces:
- Inflation Expectations: One of the major drivers Treasury pricing is driven by future expectations on inflation. Is the economy going to grow and are prices going to rise? As inflation increases, the yields on treasuries also increase. Future inflation is nonexistent at this point with the recent virus outbreak. This leads us to Market Forces as the primary driver today of the treasury market and in turn long term interest rates.
- Market Forces: This refers to basic supply and demand. Demand is driven by investors in the US along with many investors and countries abroad that park their money in US treasuries due to the safety and liquidity. The large demand for treasuries has increased prices and therefore kept yields (rates) at historic lows. On the flip side is supply. The more supply of treasuries, the lower the price and the higher the yield (remember they move in opposite directions). The borrowing needs of the US will continue to grow with deficit spending. The non-partisan congressional office (CBO) has confirmed this as well with deficits predicted to swell in the coming years
- Supply: The supply of treasuries will continue growing rapidly as the government ramps up deficit spending. The Coronavirus is forcing the United States Government to step in to assist the millions out of work (or underemployed) and support various industries that have been especially hard hit. The bigger budget shortfalls will add to the more than $10 trillion-plus rise in federal debt over the next decade that the Congressional Budget Office is already forecasting.” Treasury issuance will continue to rise as the budget shortfall increases. In a nutshell, supply will continue to increase which will drive prices down and yields up
- Demand: At the same time supply is starting to rise, the demand for treasuries is also increasing rapidly with investors clamoring for the safety of government bonds as other assets drop in value. As the Coronavirus spreads demand will continue to increase for safe assets like United States Treasuries.
What is causing the drastic swings in mortgage rates?
It has been tough to keep track of the huge swings we are seeing in the mortgage market. There are two primary drivers of the large price swings supply/demand pulls and mortgage demand.
- Supply/Demand pulls: 10-year treasury buyers are trying to figure out if demand or supply will end the tug of war. Recently treasuries were overrun with worries about supply which drove up the yields demanded. In the short term, I think supply will rule the discussion, but over the long term rates should settle back down as demand kicks in from international buyers continuing to clamor for safe assets.
- Mortgage Demand: When mortgage rates briefly dropped to around 3% owners rushed to refinance and banks were unable to handle the crush of applications. Banks kept rates high in order to increase their profitability and slow down the demand to a more manageable level. This should level out over time as rates settle in for the long term at much lower rates.
Where do we go from here?
Rates over the next 60 days should drop a bit and settle somewhere a little below 3% as the market get clarity on the true economic impact of the virus and when workers will get back on the job. Once these items are answered treasuries should level out. Furthermore, banks will space out the refinance volume and mortgage rates will track closer to historical spreads with the 10-year treasury.
Should you lock?
Unless you have a purchase or already locked in less than 3%, I would sit tight for now. Yields throughout the world have plummeted so over time United States Treasuries and ultimately mortgages will decline due to demand. If you are purchasing now, look at a 5/1 or 7/1 in order to take advantage of a lower rate while you wait for long term rates to normalize. In my opinion there is very little downside risk of rates rising substantially in the next five years on mortgage rates.
Summary:
We are experiencing interesting times as a result of the first pandemic in modern times. Ultimately markets will adapt to the new paradigm but in the interim, there will be quite a few drastic swings in the market. Now is the time to sit back and wait for the markets to settle into a more normal pattern, mortgage rates will ultimately fall from where they are now and there are no indications that anything will change in regards to rates over the next 3-5 years.
Additional Reading/Resources:
- https://www.cnbc.com/2020/08/27/powell-announces-new-fed-approach-to-inflation-that-could-keep-rates-lower-for-longer.html
- https://www.federalreserve.gov/newsevents/pressreleases/monetary20200729a.htm
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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