This past week was a head-scratcher as home loan rates ticked up slightly week over week despite the 10-year Note yield hitting a historic low of 0.31% and stocks enduring heavy losses. Typically, when stocks drop, so do rates – especially after historic stock losses like those this past week.
So, what happened?
Home loan rates are determined on the pricing of mortgage backed securities. Due to all of the recent refinance activity as a result of the low rates, the bond market was flooded with an enormous supply of mortgage bonds.
When additional supply comes into any market, prices can move lower, and that is what we saw last Monday as mortgage backed securities touched a six-year price high and started to reverse lower.
Once mortgage bonds started to drop in price, thereby increasing rates, something very interesting happened. The sell-off in mortgage bonds really gained steam causing a further bump up in rates.
Why did mortgage backed securities drop so fast?
Mortgage backed securities carry prepayment or refinance risk, which limits how fast rates drop when they are dropping. The opposite is also true. This means when rates start to rise, the prepayment or refinance risk goes away causing a sharp move lower in prices and higher in rate.
Bottom line: home loan rates remain within a whisker of the best levels seen earlier in the week. And there is an old saying, “the cure for higher rates, is higher rates,” meaning at some point as prices drop and interest rates tick up, investors will buy mortgage bonds and stabilize interest rates.
Forecast for the Week
The coronavirus fears will continue to impact the U.S. financial markets and its uncertain economic impact will continue to cast a cloud for some time. Extreme volatility in the markets will also remain until we can see some containment of the virus or some certainty.
The Federal Reserve cut rates last week in an emergency meeting and then injected further liquidity into the financial system on Thursday. That came ahead of this week’s two-day Fed meeting that kicks off on Tuesday and ends Wednesday with the Monetary Policy Statement being released at 2:00 p.m. ET. We are expecting at least a 75-basis point cut to the short-term Fed Funds Rate and it could even be steeper than that… possibly a 100-basis point cut.
Another enormous potential market mover is what the Fed says in the monetary statement on Wednesday, such as additional measures to try and stimulate the economy.
The economic calendar is packed with key reports this week, but all data will take a backseat to the Fed and the headlines surrounding the coronavirus.