Home Loan Rates: Why do they move up and down?
Keep Your Eye on MBS
The real driver of home loan rates
Mortgage-Backed Securities (MBS) are a type of Bond that provides a short-term safe haven for investments in a volatile market. Because they are less risky than Stocks, billions of investment dollars flow into them during unstable economic times. Once economic risk decreases, investors tend to invest dollars back into riskier assets, such as stocks and commodities, where they can see a greater return on investment.
How do Bonds relate to home loan rates? Simply put: when Bond prices rise, home
loan rates decline and vice versa.
What is a Mortgage-Backed Security?
A Mortgage-Backed Security (MBS) is secured by a mortgage or a collection of
mortgages. When investors purchase a Mortgage-Backed Security, they are essentially lending money to a homebuyer through a business. An MBS, for example, provides a way for smaller lenders to offer more mortgages by serving as a middleman between the homebuyer and investment markets.
Where to Look and What to Look For
To stay on top of rate movements, lenders usually track the Bond coupon that is directly below where home loan rates are currently. If rates are around 3.625% or maybe a touch higher, the 3% coupon is the benchmark to watch. If home loan rates are 4%, track the 3.5% and so on.
Rate movements can be tracked in two ways: by tracking basis points throughout the day on a Bond chart or by watching trends displayed in Japanese Candlesticks.
A Bond chart features the previous day’s performance of a particular coupon, as well as regular tracking of basis points throughout a given day.
Japanese Candlesticks also show the performance of a security in greater detail. Candlestick charts display daily trading ranges, pricing changes, resistance and support levels, as well as trends — all of which point to rate movements.
The chart below explains the key indicators within Japanese Candlesticks, how to read them and what they mean.
The Basics of Basis Points
A basis point, or bp, is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01% (0.0001) and is used to denote the percentage change in a financial instrument.
If the price of the Bond moves up 16-20bp it could push home loan rates a bit lower. On the flip side, if Bonds decline by 16-20bp, it could mean slightly higher rates.
Thresholds are important on the upside or downside to gauge whether you are in a re-price for the worse or in better territory. Basis point thresholds give you a heads up as to where interest rates may be moving in the short term or on a particular day.
The Big 3 Must-Watch Economic Indicators
Keep an eye on these 3 important factors
While Mortgage Back Securities are the real driver of home loan rates, the ebbs and flows of the economy have a direct impact on whether or not investors move money to Bonds in the short term. Below is a high-level overview of the big economic indicators — gross domestic product, inflation, and unemployment — as well as how they correlate with rates.
1. Gross Domestic Product (GDP) Report
GDP is the widest measure of the state of the economy. It is the aggregated monetary value of all goods and services. When GDP rises, demand for money rises and interest rates go up. Watch for it: 8:30 a.m. ET on the last day of each quarter.
Two reports track the rise in the cost of goods and services over time. Inflation is a Bond’s worst enemy as it erodes the purchasing power of a Bond’s future cash flows. Typically, as inflation increases, Bond prices tend to decline, while in turn, home loan rates usually rise.
- Core Personal Consumption Expenditures (PCE), the Fed’s preferred index, measures the prices paid by consumers for goods and services excluding the volatility of food and energy. Watch for it: 8:30 a.m. ET around the first or last business day of the month.
- Core Consumer Price Index (CPI) measures the change in prices over time for goods and services excluding the volatility of food and energy. Watch for it: 8:30 a.m. ET around the middle of each month.
3. Unemployment – Non-farm Payroll Report
Unemployment represents the total number of U.S. paid workers. If more jobs are created than expected, investments tend to shift from Bonds to Stocks, pushing interest rates higher. Non-farm payrolls are excluded because seasonality can skew the results without a significant economic impact. Watch for it: 8:30 a.m. ET on the first Friday of each month.
Mark Your Calendars
Data that can make investors jumpy
In addition to the Big 3 Must-watch Economic Indicators above, the monthly economic calendar is full of recurring reports that might make investors jumpy. Some of the biggest influencers that potentially have a high impact on rates are:
Chicago PMI (And Other Regional Manufacturing Data)
The Chicago PMI (officially known as the Business Barometer) is a monthly composite index based on opinion surveys of more than 200 Chicago purchasing managers regarding the manufacturing industry. The index is a composite of seven similarly constructed indexes including: new orders, production, supplier delivery times, backlogs, inventories, prices paid and employment. New orders and orders backlog indices indicate future production activity. It signals factory-sector expansion when it is above 50 and contraction when below 50. The index is seasonally adjusted. Because the Chicago PMI is released the day before the ISM (see below), it is watched in order to predict the more important ISM report, which is in itself a good leading indicator of overall economic activity. It frequently moves markets.
Scheduled release at 9:00 a.m. (CT) on the last day of the month, the day before the full ISM report.
Note: there are numerous manufacturing data points from each heavily regarded regions across the nation, such as the Philly Fed, Empire Manufacturing, and Chicago PMI.
Retail Sales Report
The Retail Sales Report is a measure of the total receipts of retail stores from samples representing all sizes and kinds of business in retail trade throughout the nation. It is the most timely indicator of broad consumer spending patterns and is adjusted for normal seasonal variation, holidays and trading-day differences. Retail sales is the first picture of consumer spending for a given month.
Scheduled for release at 8:30 a.m. (ET) around the 13th of the month.
FOMC Meeting and Meeting Minutes
The Federal Open Market Committee (FOMC) is a twelve-member committee made up of the seven members of the Board of Governors and five Federal Reserve Bank presidents. It meets eight times per year to determine the near-term direction of monetary policy. Most importantly, the Fed determines interest rate policy at FOMC meetings. Market participants speculate about the possibility of an interest rate change at these meetings, and if the outcome is different from expectations, the impact on the markets can be dramatic and far reaching. Committee meetings are usually held in January, March, April, June, July, September, October and December.
The Institute for Supply Management (ISM) releases a monthly composite index of national manufacturing conditions, constructed from data on new orders, production, supplier delivery times, backlogs, inventories, prices, employment, export orders and import orders. It is divided into manufacturing and non-manufacturing sub-indices. Financial markets are extremely sensitive to unexpected changes in this index. ISM is perceived as a good indicator of inflationary pressures. Since the manufacturing sector is a major source of cyclical variability in the economy, this report has a big influence on the markets. The Federal Reserve keeps a close watch on this report in determining the direction of interest rates when inflation signals appear. As a result, the Bond market is highly sensitive to this report. Turning points in the composite index suggest either a slowing or acceleration in the nation’s economic activity.
ISM Manufacturing scheduled for release at 10:00 a.m. (ET) on the first business day of the month and ISM Services on the third business day of the month by the Institute for Supply Management for release at 10:00 a.m. (ET).
The Unemployment Rate is a percentage of employable people actively seeking work, out of the total number of employable people; determined in a monthly survey by the Bureau of Labor Statistics. While the Unemployment Rate might look good, numbers can be skewed by the Labor Force Participation Rate (LFPR). The LFPR is the percentage of working-age persons in an economy who are employed or who are unemployed but looking for a job.
How the world’s stage can hit home
Whenever a geopolitical event occurs — and you’ll know because it makes news headlines — tensions rise globally. Within hours, investors look for less risky avenues to invest dollars. Most likely, dollars are going to flow into the safe haven of the Bond markets — like Mortgage Backed Securities.
While it’s hard to grasp the billions of dollars that move from Stocks to Bonds during geopolitical events, the move is quick and not likely to repeat soon.
This shift from Stocks to Bonds also provides a short-term lock opportunity that homebuyers can leverage. The chart on the following page provides an overview of how geopolitical events — coupled with economic indicators — affected interest rates over a 5-year period.
The Bottom Line
When Bond prices rise, home loan rates improve
Much like homebuyers looking to lock in the best rate for the life of their loan, investors seek out the best places to invest their assets.
Long-term economic indicators, timely economic reports and short-term geopolitical events all can lead to uncertainty. When there’s uncertainty, investors get nervous. When they get nervous, they shift dollars from Stocks to Bonds, which are less of a risk. Mortgage-Backed Securities are a type of Bond. The bottom line is: when Bond prices rise, home loan rates improve.
Forecast Rate Movement With Fiscal Literacy
It’s simple math, but not really
When it comes to forecasting home loan rates, you can’t predict exactly where they will land. However, you can identify a consistency and repetition in movements by watching what happens with the Big 3 indicators, geopolitical events and Mortgage Backed Securities. The chart below provides a snapshot of general rate trend tips to recognize.
Another Way to Look at Rates
Plotting the mortgage yield curve
A mortgage yield curve is a graphic depiction of interest rates and how they compare across loan terms.
Plotting interest rates on a line chart, can help you better advise your clients. How? By understanding the direction of the yield curve — and whether it is flat, normal or steep — you can easily explain whether or not interest rates will have a minimal, average or significant impact on their financing decision.
The chart below illustrates how a flat, normal and steep yield curve might look (rates are for illustration purposes only).
Flat Yield Curve
As the name suggests, with a flat yield curve differences between rates are minimal; they are nearly equal. While this situation is rare, borrowers would benefit from the exact same interest rate regardless of the loan term.
Normal Yield Curve
A normal yield curve would show a slight increase across rates but nothing particularly rattling. A normal yield curve exists when an economic environment is not subjected to various Fed actions to either stimulate or slow growth. In this situation, borrowers could expect a modest rate increase across terms, but the interest rate should have less bearing on their loan decision.
Steep Yield Curve
A steep yield curve would exist in a volatile market where increased pressures to stimulate or slow growth are present. A borrower could expect to pay more for extending the term of the loan; however, one could argue that if the Fed is trying to stimulate the economy by lowering short-term rates that long-term rates would follow suit eventually. This would open up a refinance opportunity down the road.
Click below to download the complete PDF guide for these important mortgage rate factors!