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Monday, August 31, 2015

Mortgage Bond Market Analysis - West Side Story edition

Having grown up in Stamford, CT, I got the opportunity to see a number of Broadway plays.  One of my favorite plays was Westside Story.  Ultimately it's a love story but for me when I was young and just wanted to see some action, I liked it for the fight scenes between the two gangs, the Sharks and the Jets.  The Federal Open Market Committee (FOMC) reminds me a bit of that with the Hawks and the Doves.  The doves are the members of the Fed who are cautious about raising rates since they aren't sure the economy is strong enough to justify it.  The hawks, on the other hand, think the economy is showing plenty of strength and wants to raise the rates to stem inflation.

On Friday I wrote that there were some Fed members who said a rate increase in September is highly unlikely - the members who said this were doves and they said this on Thursday or before.  Friday afternoon, there were a couple of hawks (Mester and Bullard) who said that they believe a rate hike s justified in September - mostly because of the 2nd reading of the GDP which was much higher than expected at 3.7%.  These members are alternate members and don't vote.  It should also be noted that the voting members of the Fed currently lean much more toward the dove side than the hawk side.  

Sharks vs. Jets, Part Two.  The common belief is that mortgage rates will go up as soon as the Fed starts raising the Fed Funds Rate.  But that is not likely to happen, immediately anyway, and here's why.  The stock market as done really well over the last few years because of the various stimulus programs that have been in place including the Fed's Quantitative Easing programs and their policy of low rates.  This has made bonds unattractive as an investment because of their extremely low yields which has meant a lot more cash flowing into the stock market which has what pushed the market to record highs recently.  As the economy grows and more people are employed and have money to spend, business profit and the GDP grows along with inflation as the price of goods increase because there are more consumers who can afford to buy the goods.  When this happens, the Fed raises the Fed Funds Rate in an effort to slow down economic growth and keep it at a manageable pace.  As rates go up, bonds become more attractive to investors, especially when they think that stocks might be reaching a top.  Additionally, we saw the stock market take a plunge recently when the markets around the world started selling off, in part, due to the belief that the stimulus policies were done.

The People's Bank of China stepped in and took action to support China's falling stock market which helped our market recover a bit as well but we got a glimpse as to what could happen in the near term when investors think that low rates that support investments in the stock market will be going away:  stocks sell off and money flows into bonds driving bond prices up and interest rates / yields lower.    There's one other thing to consider.  Inflation erodes all returns (ROI) but especially the low yields of bonds.  For example, if inflation is at 3% and the bond you are invested in has a yield of 3%, you are keeping pace with inflation but your money isn't growing.  Until the yield on bonds (and yields between bonds - corporate, treasuries, municipals, mortgage and junk bonds - vary widely) is higher than inflation, stocks are typically more attractive to investors because there is opportunity for growth.  

This is a lot to keep in mind and if you don't have to because this is one of the things I am happy to do for you.  I'd love to get your thoughts on this subject in the comments section or in an email ( or you can call me at 702-812-1214 or 801-853-8720.  If you are a client are in need of a mortgage, I'd love to help with that and show what I can do in addition to the interest rate advice I provide.  

Should I lock or float?  I'd float with caution in the very short term.  Wednesday starts the various jobs reports for the week.  The FNMA benchmark bond closed up 9 basis points on Friday and is up 15 basis points this morning.  The Chicago PMI (Purchasing Manager's Index) came in at 54.4, just below expectations of 54.5 and below the previous reading of 54.7 but any reading over 50 is expansionary so this is good for the economy.  There is a lot of data between now and 9/16 which is when the Fed will meet to discuss a possible rate hike.  In the short term, I'd lock by tomorrow afternoon ahead the jobs reports and other data coming out on Wednesday.  Keep a close eye on the market if you decide to float and make it a great day. 

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