The phones at Finworth got a work out yesterday with the Fed’s move. All this talk in the press of macro economic policy is great, but our clients just want to know simply, ‘what does this mean for mortgages.’ The short answer is that it will help mortgages like Home Equity lines that are based on prime, and it will help some of the other short term instruments that follow the 2 year, 3 year, and 5 year Treasurys; like 15 year fixed loans. However, it is likely to hurt the 30 year fixed rates. In fact it already has. Yesterday afternoon, the 10 year treasury (which is what the 30 year fixed follows – why can’t they make this easier?) had a bad afternoon while everyone else was deliriously happy. Today is shaping up to be a rather bad day for the 10 year. The yield is up to 4.55% which is a respectable spike.
The long answer, for those wanting to dig deeper, has the typical convolutions and equivocations of economic theory. But before jumping in, read what the Wall Street Journal had to say this morning about the rate cut in relation to the mortgage market:
Wall Street Journal – September 19, 2007; Page D1 – By JANE J. KIM and RUTH SIMON
Consumers should soon start feeling the impact of the Fed rate cut, including reduced payments on many home-equity lines of credit, credit cards and some car loans. But the rate cut doesn’t offer much help for the key problems bedeviling many mortgage borrowers. Perversely, however, some economists say it could lead to higher rates on fixed-rate mortgages down the road if bond markets expect the Fed move will spur higher economic growth or inflation…the Fed cut could boost rates down the road for 30-year fixed-rate mortgages. These rates are typically influenced by rates on 10-year Treasurys, which have moved lower recently in anticipation of a quarter-point cut in rates and because of a flight to quality in bond markets. But if markets expect a higher level of economic growth than previously anticipated, or a pickup in inflation, borrowers could see higher rates.
So on to the more in depth answer. There are only a few interest rates on the planet that are actually set in a static way by humans. The rest are all determined by the powerful forces of markets. The Federal Funds rate is determined by the Fed (yes they are humans). There are a few rates that follow lock-step, like the rate that the banks call Prime, but most all the other interest rate indices move when people buy or sell the bonds they reflect. So here is the confusing part, if the Fed cuts the rate that they control, what happens to all the rates that the market forces control? The answer is…it is different each time, so who knows????? Take mortgage rates for example. The market might like what the Fed is doing and therefore become more bullish on buying up Treasurys. If they buy up a bunch of 2 year and 3 year Treasurys, the rates on ARM loans might drop. If the market buys up a bunch of 5 year Treasurys, then the 15 year fixed rate might drop. And if the market is bullish on buying up some 10 years…then the good ole 30 year fixed might drop. If the markets dislike what the Fed is doing with rates, then bond folks might get bearish and start selling. The mortgage rates would then rise.
Now throw a wrench in that plan. What if I am a bond buyer and I think that the 2 year and the 3 year will benefit from the Fed move, but the 10 year will not? That is what happened yesterday. Everyone loved the short term bonds and they bought like maniacs. Remember Econ class? If everyone wants something, the price goes up. If the price goes up, the yield goes down. When the yield goes down the rates go down. So it was a good day for 15 year fixed loans. However, the bond buyers did not like what the Fed move might mean for the long term, so they shunned the bonds like a pariah. No one wanted them, so the price fell. The price fell and the yield went up. So…it happened. The Fed cut the Federal Funds rate and the 30 year fixed rate actually spiked. Wow. Can you imagine our phone calls yesterday?
The forces that are acting in the market are so different that they sometimes seem to take the same action even though their goals might seem incompatible. In recent years, lots of people have wanted America’s debt (which is what a Treasury is by the way). The Bank of Japan loved to buy Treasurys for example. Why? Well, if they buy Treasurys it can help prop up the dollar against the yen. They don’t want the yen too strong against the dollar! That would make the price of their cars and electronics too much for the American consumer to digest. So they buy Treasurys on strategic days.
Other people buy Treasurys too. Hedge Fund folks, Mutual Fund folks, Pension Funds – each of them have a plan to spread the love around in their portfolios to mitigate volatility and risk. Sometimes, these types of buyers like to buy a bunch or Treasurys right before they have to give a prospectus to investors. Sort of like cleaning up your house from the party before Mom and Dad get home. We all like to know our money managers have tidy little asset allocations.
Sometimes, people buy Treasurys because they need a safe haven investment. We all like to buy them before a long weekend in case there is a terrorist attack. Sometimes, we like to buy them right before we go to the Hamptons for the summer so we don’t have to sweat the market while we are at P’Diddy’s party.
Ultimately, all these buying and selling forces aggregate and move things one way or another. Last year, it was a lot of foreign buyers wanting to prop up the dollar. Last month, it was the flight to safety buyers who were freaked out by the roiling credit markets and liquidity constriction. All this buying has kept our good ole 30 year fixed pretty low. But things changed the moment Ben Bernake uttered the words yesterday. Because now people are worried about inflation.
What? Inflation? I thought the Fed has been worried about inflation all along? Surely they would not do something that might make inflation worse? Well, yes they did. The Fed was unable to reconcile the unsustainable disconnect between not enough money, and too much money. Yes, the Fed is very worried about inflation as are we all. But when money got tight a few weeks back, the banking system was seizing up. So the Fed pumped some billions into the economy. That’s right. Increased the money supply and thereby increasing the risk of inflation. Now, the liquidity constriction is not better, so the Fed had to make another move to lubricate the machine and head off a potential pinch for the American consumer.
So they lowered their benchmark rate. But boy oh boy is this bad news for the value of a dollar and the increasingly gruesome specter of inflation. So the long bonds are stumbling because inflation would really erode their value. So 30 year fixed rates are heading north for the time being. Of course, if you have a home equity loan based on prime, or a bunch or credit card debt, or if you might be nuzzling around for a new car, the rate cut is probably welcome news. More on this next week as things unfold.
By the way – the two brand promises of Finworth (and our core message to our clients) are ‘Expect More’ and ‘Borrow Wisely.’ Back when everyone was drunk on their ability to loan and to borrow, the Borrow Wisely thing made us seem like party poopers. Right now, we are hearing more and more from our lending relationships and our clients that we really might have been on to something all along.
Respectfully and Sincerely Yours,
Steve Curnutte and the folks at Finworth
Borrow Wisely…
