The Ups and Downs of Mortgage Rates

THE UPS & DOWNS OF MORTGAGE RATES

Where do rates come from?

The general wisdom is that mortgage rates tend to follow the treasury yield. However, this is not always the case, and on some days, do the opposite.

Mortgage bond prices, not treasury yields, drive mortgage rates. But, real-time mortgage bond prices are tough to follow – it’s not readily available information. The real-time treasury yield is easy to get, so the public has relied on that and the historical relationship of the treasury yield and mortgage rates to get a feel for what mortgage bonds are doing.

It is important to remember that we are dealing with two different markets – mortgages and treasuries. Both are bonds, which mean they are attractive in ways that are opposite the stock market. But, each market works on its own dynamics. In other words, just because a treasury is attractive to investors, a mortgage bond may not be. Exhibit A: the recent subprime mess -- questions about the ratings reliability on mortgage bonds and the mortgage market in general have left investors leery of mortgage bonds.

What about the Fed?

It is common but flawed to assume that mortgage rates are directly related to the Fed Funds rate. Although they typically cause some reaction in the bond markets, a Fed Funds rate cut is not a predictor of bond prices. In fact, there are times when the Fed rate has been cut that and mortgage rates have gone up. A rate cut does not always mean an increase in bond prices. Historically, there is no correlation between Fed Funds rates and mortgage rates. Any market pattern seen between Fed Funds and mortgage rates will be due to overall economic conditions.

In terms of future mortgage rates, there is plenty at play. Volatility in the stock market, uncertainty and fear regarding the mortgage credit market, the value of the dollar, rate cuts and resulting credit expansions, economic or inflation data, all can send investors in different directions (i.e. to the stock market to the detriment of bonds, or the opposite) causing mortgage rates to rise or fall to the Fed rate, but generally trending along with it over time.

Compiled from information provided by Sunny Shannon, Eustis Mortgage Corporation