This is an interesting time in financial markets, and we want to help you understand the many elements currently in play. Investors face a lot of significant questions on a wide range of issues right now, and it's no surprise that they have responded to the increased uncertainty by reducing the level of risk in their portfolios. As usual, their primary method to accomplish this has been to shift assets from stocks to bonds, including MBS. The trade tensions between the U.S. and China remain one of the largest sources of concern for investors. Tariffs and other barriers to trade slow global economic activity, which reduces the outlook for future inflation and is favorable for mortgage rates. The outlook for global economic growth is another big question mark for investors. Around the world, the manufacturing sector clearly has taken a hit from the trade issues, and business investment has fallen as companies hesitate to make long-term capital commitments. On the other hand, U.S. consumer spending has remained quite healthy in recent months, and Alibaba ("the Amazon of China") just released strong earnings results. In addition, several geopolitical events around the world are concerning. Massive protests have been taking place in [...]
There are several big picture factors which are viewed as negative for long-term bond yields, but investors have been aware of them for months. It’s not unreasonable that mortgage rates have climbed to the highest levels in four years. What’s harder to figure out is why the increase took place over the last couple of weeks without any significant fresh news. First, the supply of bonds issued by the Treasury is increasing due to larger government deficits resulting from policy changes. Yields generally need to rise to entice investors to purchase additional bonds. Second, the new policies potentially will lead to faster economic growth, which could increase future inflationary pressures. Finally, investor expectations for the pace of tightening by the Fed have increased. Investors now assign roughly a 50% likelihood that the Fed will raise the federal funds rate four times in 2018, up from very low levels at the start of the year. In addition, the Fed is reducing its enormous holdings of Treasuries and mortgage-backed securities, which adds to the supply of bonds.
In her semi-annual testimony to Congress, Fed Chair Yellen said that the Fed expects that economic progress will call for "further gradual increases" in the federal funds rate. She also said that it would be "unwise" to wait too long to hike rates. Yellen later added that the Fed will consider in coming months when to begin to reduce the Fed's holdings of MBS. Of note, she said that the Fed will not sell MBS to shrink the holdings, but rather will stop replacing principal reductions. The expected pace of tightening by the Fed increased a little after her testimony, causing MBS to decline.
As widely expected, the Fed raised the federal funds rate by 25 basis points. Unfortunately for MBS, Fed officials also raised their outlook for the pace of future rate hikes. They now forecast three rate hikes in 2017, one more than previously projected. The faster pace was viewed as negative for mortgage rates. But why? The purpose for raising the federal funds rate is to keep inflation from rising above the Fed's target of 2%. This should be a good thing for mortgage rates. Part of the reason for the adverse reaction stems from a more direct effect the Fed has on mortgage rates. The Fed owns over $1.7 trillion of the agency mortgage-backed securities (MBS) that it purchased during its quantitative easing (QE) days. The Fed keeps the balance of MBS around that level by buying new MBS to replace that which pays off. The Fed is currently the buyer of approximately 25% of all newly issued MBS. This added demand from the Fed drives MBS prices higher and mortgage rates lower. The Fed says that it will not allow its holdings of MBS to decline until "normalization of the level of the federal funds rate is well under [...]
This week, a major influence on U.S. mortgage rates will be the “Brexit vote on Thursday. It is very difficult to predict the effect on the global economy if the UK were to leave the European Union or whether it would lead to similar votes in other countries. Due to the economic uncertainty which would result, a vote for the UK to exit the EU is expected to be positive for U.S. mortgage rates, while a vote to remain would be negative. As each new poll shifts the odds, investors react immediately. This increases daily volatility, as investors factor the expected outcome into asset prices. For example, the latest poll showed greater support to remain, and mortgage rates have moved higher today.