Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market.
Why Mortgage Bonds?
When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other “securitizers”. These “securitizers” get their money by issuing bonds to bond market investors. These bonds are called “mortgage bonds” or “mortgage backed securities”. Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market.
The Role of the Federal Reserve
As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive down interest rates and stimulate the economy. This is called “quantitative easing” or “QE”, and we’ve had several rounds of QE so far.
Currently, the Fed owns a whopping $1.75 TRILLION in mortgage bonds!
In fact, the Fed has been the biggest buyer of mortgage bonds in recent years, and is currently absorbing over half the supply of new mortgage bonds being issued in the market. If the Fed stops buying mortgage bonds, mortgage rates could increase by up to 2% vs. where they are today.
The Fed has indicated that they will stop or slow down their purchase of mortgage bonds once they “normalize” the short term rate known as the Fed Funds rate. This is expected to happen sometime in 2017.
In the meantime, the market will be watching very closely to see if the Fed changes their timeline on this. The Fed has already changed their timeline a few times, and they may do so again as new economic information comes to light.
Another major factor that may impact mortgage rates this summer is the phenomena known as “negative interest rates”. Throughout this year, over 30% of global government bonds have been trading on negative yield; and approx. 70% of government bonds have yields lower than one percent. This was caused by a “flight to quality” in the financial markets as investors started buying government bonds on fears that an economic slowdown in China would spill over into the rest of the world. There were also other factors at play in the markets, and government bond yields remain low. This is causing mortgage bonds to look very attractive by comparison because the yield on Fannie Mae, Freddie Mac and Ginnie Mae mortgage bonds is higher than the yield on government bonds.
Mortgage rates may remain low if this “flight to quality” continues. On the other hand, mortgage rates may begin to move higher if the yield on government bonds move higher as well.
Here are Three Economic Reports that May Impact Mortgage Rates in the Coming Months:
- Jobs Report: bond investors and the Fed watch the jobs report and unemployment numbers very closely to determine if the economy is improving and whether they should buy, sell or hold mortgage bonds.
- Inflation Report: bond investors and the Fed watch the inflation reports (CPI and PCE) to determine whether they should buy, sell or hold mortgage bonds.
- Gross Domestic Product (GDP) Report: bond investors and the Fed follow the GDP numbers to determine if the economy is growing and whether they should buy, sell or hold mortgage bonds. (GDP measures the size of the economy and whether it’s growing, shrinking or stagnating.)