Special Report: Coronavirus and Rates | March 5, 2020 As the number of reported cases of the coronavirus around the world has increased, the list of school closings, work interruptions, event cancellations, and other consequences has grown. This decline in economic activity has been brutal for stocks but good for bonds, pushing rates to record low levels. One commonly heard question, though, is why mortgage rates have not fallen as much as government Treasury yields. There are two main reasons. First, mortgage-backed securities (MBS) have prepayment risk while Treasuries do not. When people refinance, their loans are removed from MBS. This makes MBS less valuable to investors relative to Treasuries during periods of declines and more valuable during periods of increases. In other words, mortgage rates rise and fall more slowly than Treasury yields due to the basic properties of prepayment risk. Second, the large mortgage companies which purchase loans and set mortgage rates have the capacity to process only so much business at one time. Currently, there is more demand for loans and refinancings than these firms can handle, so they have less incentive to pass along the lowest possible rates to customers. Here are some actual figures from [...]
The housing market data has been somewhat disappointing this year, and the most recent reports did little to reverse the trend. In July, both new and existing home sales decreased a little from June. For existing home sales, which make up roughly 90% of the market, this was the fifth straight month of declines, and they were lower than a year ago. The inventory of existing homes available for sale fell slightly from June to a 4.3-month supply. A 6-month supply is considered a healthy balance between buyers and sellers. Sales of new homes fell to the lowest level since October 2017. A number of factors have contributed to the loss of upward momentum in home sales this year. One big reason is a lack of inventory in many regions, especially for lower priced homes. Single-family home construction is essentially flat from a year ago, and it is not meeting the demand at the lower end of the market. Builders say that rising land, material, and labor costs are obstacles to a faster pace of construction and make adding entry-level homes less desirable due to lower profit margins. For decades, single-family housing starts averaged about 1.1 million per year. Following [...]
After its meeting concluded on June 14th, the Fed provided some details about the plan to reduce its holdings of U.S. Treasuries and agency debt and mortgage-backed securities (MBS). Regarding the starting time for the reductions, Fed Chair Yellen said that they could begin “relatively soon if the economy performs in line with the Fed’s forecasts. This comment caused investors to anticipate that the starting time will be in September or October, which was sooner than expected. In a document called the Policy Normalization Principle and Plans, the Fed laid out additional information. They will reduce their holdings by not reinvesting all the principle payments received. Over the last few years, they have held the level of their holdings steady by reinvesting all the principle payments received. The amount of principle payment received that will not be reinvested will start at $10 billion per month and will grow by $10 billion every three months until the monthly total reaches $50 billion. The reduction then will be capped at $50 billion and will continue until the size of the Fed’s holdings has fallen to the desired level. The Fed did not disclose the desired level but did say they expect the [...]
During the quantitative easing years of 2008 through 2014, the Fed acquired trillions of dollars of Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities (Agency MBS) and U.S. Treasuries. Its balance sheet grew from under $1 trillion to over $4 trillion. The Fed stopped adding to its holdings a few years ago, but has maintained a policy to reinvest principle payments received, thus maintaining a steady level of investments. At times over the last few years when refinance activity was high and the Fed was reinvesting the principle payments it received, the Fed was the buyer of the vast majority of all newly issued Agency MBS. Even recently, the Fed has been the buyer of approximately 25% of newly issued Agency MBS. The demand from the Fed for Agency MBS has had a positive effect on mortgage rates. For the past few months, Fed speakers have been saying that the time to begin “normalizing their holdings was near. But few details were provided. The minutes of the Fed’s May 3nd meeting, released on May 24th, provided some details about their plan. Although many details remain unknown. The plan calls for the Fed to tell investors the maximum amount it [...]
The first round of the French Presidential election will take place on Sunday. It is significant for global markets because of its potential implications for the future of the European Union (EU). The two candidates who receive the most votes on Sunday will proceed to the second round of voting on May 7, and the latest polls show that the top four candidates are very close. Two of these four (Le Pen and Melenchon) favor exiting the EU. The possibility that an anti-EU candidate could win has caused investors to shift to safer assets, which has helped mortgage rates in recent weeks. A strong showing by the anti-EU candidates would be good for mortgage rates, as investors likely will shift additional funds into safer assets. If they do poorly, it is expected that investors would shift back into riskier assets, which would be negative for rates.