Weekly Rate & Market Update 9-2-16
Question of the week: How come when the market is bad rates drop and when market is good rates rise?
Answer: Last week we looked at the relationship between the price of a mortgage and the mortgage’s interest rate. Using a teeter-totter we saw that the lower the interest rate the higher the price and vice-versa. This week we look at another inverse relationship, that between the economy and investment markets and interest rates.
Most people know that when the economy is going well stock markets rise. Your retirement account through your employer increases in value and the news is peppered with higher earnings, higher profits and record numbers for the major indexes—the Dow Jones, NASDAQ and S&P. Correspondingly when the economy is doing poorly, as in a recession, stock markets drop, your 401(k) or other retirement account decline in value and business news talks about missed earnings and declining or negative profits.
This makes sense, if the economy is strong people are spending money, companies are selling more and more of their goods and services so they have higher profits which makes the companies more valuable, which is reflected in stock prices.
So why is it when there is good economic news and the economy is improving bond** prices drop and when there is bad economic news and/or the economy is improving bond prices rise?
**Mortgages are traded as Mortgage Backed Securities as discussed two weeks ago, MBS prices move up and down with bonds such as U.S. Treasury and large corporate bonds.
Think of our teeter-totter, when prices drop rates increase, when prices rise rates drop. So why do bond, and therefore mortgage, prices drop when stock prices increase? And vice-versa when stock prices drop mortgage prices increase?
The greater the risk the greater the return, perhaps the most basic axiom for finances and investing. Less known is the term flight to safety.
Flight to safety is one reason why interest rates drop when there is bad economic news and uncertainty for the future. Investors flee the more risky investments like stocks and purchase safer investments, like bonds, and mortgages, which pay fixed rates of interest rather than risk sudden drop in prices should they leave their money in stocks, or equities.
Another reason for interest rates dropping when there is not so good economic news is investors purchase bonds. Investors not only are motivated by the flight to quality principle, but also because the long term expectation is for interest rates to drop due to other investors buying bonds but also in anticipation of moves by central banks lowering rates to stimulate borrowing to stimulate the economy.
As investors move into bonds prices go up with the increase in demand. Increased demand in a market generally causes higher prices, higher prices in bonds means lower interest rates.
When the prospect is for a growing economy investors sell their bond holdings and purchase stocks. This causes the price for bonds to drop and interest rates to rise.
As a general rule if stock prices are increasing then interest rates are as well, if stock prices are dropping then so are interest rates. That is the general rule which has been broken in our post-recession economy as rates have dropped and remained historically low despite the sharp increase in stock prices. This is primarily due to the tremendous amount of money put into the economy by the Federal Reserve during and in the years after the recession, the Fed retaining ultra-low interest rates for the seven plus years since the recession ended, and an economy that while not in recession has grown slower than any post-war economy following a recession. In the meantime corporations have increased profits by reducing labor costs and the cheap access to capital caused by the low rates.
When our economy ends its current cycle and begins the next it will be interesting to see how interest rates react. If they historical tie between higher rates with higher stock prices returns or if the two remain somewhat disconnected as they have been for the past decade.
This wraps up our four week discussion of mortgages and what they are and how they work, I hope you have enjoyed it and I was able to increase your understanding.
For those just catching up here is the series on mortgages from the past few weeks:
8/12/16: I have a Fannie Mae loan, why am I not making my payment to Fannie Mae?
8/19/16: What are Fannie Mae, Freddie Mac and Ginnie Mae?
8/26/16: Why are there different prices for the same loan?
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Employment and income dominate the economic news this week. On Monday Personal Income and Outlays for July showed incomes grew 0.4% from June and spending rose 0.3% from the prior month. Spending growth slowed from June which is of some concern since consumer spending is 65-70% of our economy. Personal savings grew in the month, again not a strong positive for the economy. Prices were flat for the month giving no price side reasoning for the Fed to raise rates. Overall the data was neutral for mortgage rates.
Of bigger impact was the monthly jobs report. Being the first Friday of the month the Labor Department released the numbers for employment in August—and the news is not great. After adding 275,000 job in July the economy added only 155,000 in August, of which only 126,000 were in the private sector. August jobs reports are a bit quirky with summer employment and auto manufacturers flexing employment to retool for new models, even with the quirkiness however the news is not positive. Since the Fed has repeatedly indicated they are focused on employment for their rate decisions the data supports no move on rates by the Fed later this month.
Under-reported but having a tremendous impact on the economy is the bankruptcy of the Hanjin shipping line. Hanjin is a South Korean shipping company that is one of the major players in the Ports of Los Angeles and Long Beach. Hanjin ships carry approximately 5% of all ocean trade. Ocean shipping is 90% of global movement of goods so Hanjin impact global trade. Right now millions of containers containing billions of dollars of goods are sitting on ships in ports and harbors around the world because ports are not off-loading or on-loading Hanjin ships. Goods meant for American retailers for the Christmas season are in many of those containers. There is a ripple effect of goods not moving for one ocean line that impacts a port and causes delays for other lines containers being moved, immediately there has been a tremendous increase in shipping costs of containers on sea and land If the ripple effect multiplies it could cause some damage to not only our economy but others globally. Keep an eye on this issue.
Rates for Friday September 2, 2016: I need to do some research, but I cannot recall a time when conforming fixed rates were flat for seven straight weeks and the same for nine out of ten. It shows that there is no major news to impact investors, which means no significant good or bad news. I maintain my advice to take advantage of these rates and lock in when you can.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 3.25% Flat
30 year high-balance conforming 3.50% Flat
30 year FHA 3.00% *** Flat
30 year FHA high-balance 3.25% *** Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down (3.5% for FHA) with 740 FICO score for purchase mortgages. ***FHA rates have may have no points and credit towards closing costs, changes daily.
Have a great Labor Day weekend. It will special in the Smith household as Leslie and I celebrate our twenty-second anniversary on Sunday—I celebrate every day that this wonderful woman is my wife, but glad she celebrates at least once a year!
Have a great week,
Dennis
