Mortgage Rates to Remain Low until Inflation Kicks Up
I have been meaning to write about what I expect mortgage rates to do once the Federal Reserve ends its purchases of Government Sponsored Enterprise (GSE)-backed mortgage bonds (i.e. Freddie Mac, Fannie Mae, and Ginnie Mae). The Fed stepped into the market to support liquidity in the housing industry, and is expected to complete its $1.25 T in the next month. The big question has been, “What will happen to mortgage rates?” when the Fed stops buying.
There are some who would argue for an expected increase of 50 basis points in spread widening between treasuries and Mortgage-Backed Securities (MBS). (By the way, Calculating Risk is becoming one of my favorite financial blogs.)
It certainly makes sense to suggest that the price for MBS will fall (and hence yields will rise) once the major buyer of these securities stops buying. However, I don’t think that this will happen, and its a perfect example of why statistics can bite you in the rear when analyzing market trends.
This graph from Politico.com shows the history of 30 yr mortgage rates in relation to 10 yr treasury bonds.
The problem is that it is in the past, and does not reflect the fact that today the GSE’s are wholly-owed subsidiaries of the US Government. The current private market buyers of MBS now consider these bonds to essentially be the same as treasuries (and so does the Congressional Budget Office). Until this changes, the MBS will continue to trade at historically compressed levels compared to treasury bonds, and mortgage rates will continue to remain low.
One could also argue that the recent troubles in the EU may actually cause money to flow into the US fixed income markets, further compressing spreads as foreign buyers of these fixed income securities seek greater yields than are offered on treasuries.
For mortgage rates to significantly change, the following needs to happen – (1) inflation begins to be priced into the market and 10 yr treasury yields go up (maybe), and/or (2) the US Government stops backing the GSEs (unlikely), and/or (3) the Fed starts selling its $1.25 trillion holdings of MBS (again unlikely).
