If you’ve been following interest rates lately, you might have whiplash. Rates have gone up, then back down, then up again. And that’s all in the same day.  Over the last year mortgage rates have been more volatile than at any time in the nearly 17 years I’ve been following them. But in the last few weeks, since the credit crunch hit, the volatility has gone through the roof. Mortgage rates have tested their high point for the year, then swung around and dropped to the best rates we’ve seen in the last few months, before swinging back the other way and nearing the yearly highs again. What is going on with mortgage rates?

In normal times, mortgage rates go up and down based on activity in the mortgage backed securities market, and the prices move based on how traders read the state of the economy and the possibility of inflation in the future. Inflation brings down a bond’s yield, so any hint of inflation is going to decrease the value of a mortgage bond, meaning interest rates will go up. On the other hand, when the economy is slowing down this means that the yield is safe, so more investors buy in and mortgage rates go down. That is how it works in normal times. But these aren’t normal times.

All the economic reports point to a slowing economy, which should mean that rates go down. But that hasn’t been the case. Oil and commodity prices have dropped like a stone in the last two months. This should have made rates go down, but it didn’t. Unemployment is up, and so are foreclosures, while the stock market and home values are down. All of these should mean that rates are going down. Yesterday the consumer confidence index slipped to an all time low, and mortgage rates got worse. In fact, the normal concerns of inflation and economic slowdown don’t seem to have any correlation with mortgage rates now. So again, what is going on?

I think there are two explanations for what we are seeing, de-leveraging and panic. I’ve talked about de-leveraging before. This is like a margin call on the markets. Big investors, including mutual funds and hedge funds, have borrowed heavily to leverage the return on their investments. This strategy works great when the market is going up, a small amount of money controls a bigger investment and the returns are magnified. But what works well on the way up can be a killer on the way down. The losses are now magnified and in order to pay back the losses, investors are forced to sell everything they have – the good as well as the bad. The other explanation is panic. In a time of uncertainty everything is suspect and nothing does well. This needs to play itself out and confidence needs to return before the markets can stabilize.

But I do see two things which make me think that mortgage rates are still likely to go down.

1 – The risk for holders of mortgage bonds has gone down. Now that the Government has taken control of Fannie and Freddie mortgage bonds, are nearly as safe as treasuries. So as long as there is faith in the US economy (So far, so good. The dollar has gone up during this crisis) having the US government standing behind them, mortgage bonds should out perform other investments from a risk standpoint.

2 – The goal of the Fed and the Treasury is to get the economy growing again, and in order to do this the housing sector needs to get healthier. Treasury Secretary Paulson has said that one goal is to get mortgage rates down so that home owners have an incentive to buy. That hasn’t worked out so well yet, but over time it is likely.

The Fed is expected to cut the Fed Funds rate today by .50%. This will mean that rates for business loans and home equity loans drop, but it won’t necessarily help mortgage rates. Often mortgage bonds worsen after the Fed cuts rates. But usually within a week or so, the market sees a benefit and rates do drop. No one knows the timing, and in this crazy market there are no hard and fast explanations. But don’t be surprised if rates do start dropping again soon.

Illinois Mortgage Rates and News                    First time home buyer loans

Tags: direction of mortgage rates, market volatility, mortgage rates

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