What is Driving Rates?

With the markets performing in ways that defy common economic logic, it’s important to understand the dynamics that are causing mortgage interest rates to move sharply higher at a time when most would guess rates would be falling.

There are many underlying forces that are contributing to this.  I’ll outline a few:

1 – The stock market fall has triggered margin calls for many investors.  As a result, some have been forced to sell other types of assets to raise the cash needed to cover their margin calls.  Because bonds are relatively liquid assets (easy to sell), investors are selling their bonds to raise cash.  This is driving the price of bonds lower and interest rates higher.

2 – The one trillion-dollar (or more) plan that was recently announced by the Trump Administration needs to be paid for.  The Treasury Department is expected to sell Treasury bonds to raise the cash.  The massive increase of debt issued to the market drives interest rates higher to meet demand.  Investors are trying to determine how much of a premium they will demand to cover the flood of bonds being sold on the market.  Until we find equilibrium, rates will be volatile.

3 – Generally speaking, large levels of government debt helps suppress mortgage interest rates.  However, when debt levels are expected to increase rapidly, there is a short-term impact that adds upward pressure to rates.  In addition to the stimulus plan, unemployment benefit claims are expected to skyrocket.  This will add additional expenses to the Federal Government and cause debt to increase rapidly.  Without knowing the appetite investors will have to purchase this debt, rates will rise until the supply of buyers matches the demand.

4 – The amount of refinance activity in the market has shortened the average life span of a mortgage.  It takes years of a mortgage loan staying on the books before it is profitable.  With consumers quickly refinancing, investors are losing money.  Therefore, they are demanding a higher rate of return to continue to purchase mortgage bonds.  This drives rates higher.

5 – Treasury Secretary, Steven Mnuchin recently said that we are at risk of seeing an Unemployment Rate of 20%.  This adds a lot of uncertainty to the markets and creates a lot of concern that many will not be able to make their mortgage payments.  As mortgage defaults increase, investors in mortgage bonds will lose money.  This will drive interest rates higher to help keep investors interested in buying mortgage bonds.

As the market adjusts to the changes, we can expect to see volatility in the markets.  Eventually, I believe rates will stabilize and come back down.  Maybe not as low as we saw in early March, but better than we have today.  We will keep you updated as the market changes.