Mortgage Rates and Fed Funds
With the US Federal Reserve decreasing the target Fed Funds rate to 0% over the last week, many immediately turn to mortgages and want to take advantage of potentially low rates. Unfortunately what they will find may be a bit surprising.
Mortgage rates and yields in the bond markets move based on many variables. There are too many variables to name in this simple little blog, but here are the important issues that we encountered in the last two weeks.
Stock market decline Most US Equity markets were close to their all time highs in February of 2020. As the effects of the Novel Coronavirus began to be priced into the stock markets, equity prices went into recession territory very quickly. At the initial stages of this stock market decline, it was obvious that people were selling equities and moving that money into bonds of various sorts. As people buy more bonds, the price of thos bonds increase while the interest rates thamey are paying don't change. So if you take that old interest rate but divide it by the new higher price, you get a lower interest/price or what is referred to as Yield. You can see this change from about Feb 19 2020 to Mar 2 2020.
Fed Funds Target to 0.50% on Mar 3 The Fed announced it was reducing its target for the Fed Funds Rate to 0.50%. This is generally done to indicate that the Fed is supporting banks with liquidity they may need to give loans to consumers and businesses during tough times in order to encourage banks to provide support to the economy via lending.
Banks and markets hoarding cash In the days after the initial Fed remote cut, the impacts of COVID-19 become more wide spread as it become obvious that large swaths of the economy were going to be shut down for several weeks. The equity and bond markets along with banks became fearful of potential slow downs. Banks begun pricing in the potential for loan defaults, foreclosures, and bankruptcies which resulted in a lower appetite for lending. This actually caused rates to jump up. You can see this in the charts and tables beginning on 3/2.
Demand for mortgages At the same time that banks began becoming concerned about loan defaults and liquidity concerns become prevalent in all aspects of fixed income markets, consumers began reaching out to banks to refinance loans in droves because they assumed rates would be low. This increase in demand combined with the reduced supply of money resulted in a sharp increase in mortgage rates as we approach March 19th 2020.
So what's next? If our problem can be described as a lack of liquidity in the lending markets, the US Federal Reserve can be described as not only turning on the faucets but hooking up all the fire hoses and spraying as much liquidity as the banks desire into the system. They have committed to supporting money market funds by puchasing commercial paper. They have committed to buying hundreds of billions in the REPO markets every day. They are essentially using everybtool they have to flood the lending systems with money supply. This will take a few weeks to satisfy the fears of banks and the bond markets, after which we should see rates dip down again.
The effects of all of this new money supply combined with increased fears of loan defaults has completely separate effects on bond markets, but we will leave that for another post.
On mortgages, the best advice for now is as follows. Rates are still historically very low. Just check out the chart below. However, if you were already locked in with rates in the 3s or low 4s, it may make sense to just wait a little longer to refinance in order to make sure you can achieve a rate low enough to warrant the closing costs necessary for that new loan.
As always this is not intended as advice for any particular individual situation. Talk to your advisors to understand how these issues may affect your needs and plans.